e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the quarterly period ended: June 30, 2008
Or
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from: to
Commission File Number: 0-26820
CRAY INC.
(Exact name of registrant as specified in its charter)
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Washington
(State or Other Jurisdiction of
Incorporation or Organization)
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93-0962605
(I.R.S. Employer
Identification No.) |
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411 First Avenue South, Suite 600
Seattle, Washington
(Address of Principal Executive Office)
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98104-2860
(Zip Code) |
Registrants Telephone Number, Including Area Code:
(206) 701-2000
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days: Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in
Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o
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Smaller reporting company o |
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(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act) Yes o No þ
As of July 31, 2008, there were 33,364,934 shares of Common Stock issued and outstanding.
CRAY INC.
TABLE OF CONTENTS
Available Information
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K,
amendments to those reports and proxy statements filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act are available free of charge at our website at www.cray.com as
soon as reasonably practicable after we electronically file such reports with the SEC.
Cray
is a federally registered trademark of Cray Inc., and Cray X1E, Cray
XD1, Cray XT3, Cray
XT4, Cray XT5, Cray XT5h and Cray XMT are trademarks of Cray Inc. Other trademarks used in this
report are the property of their respective owners.
2
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited and in thousands, except share data)
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June 30, |
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December 31, |
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2008 |
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2007 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
90,110 |
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$ |
120,539 |
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Restricted cash |
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10,000 |
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10,000 |
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Short-term investments, available-for-sale |
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14,901 |
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48,582 |
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Accounts receivable, net |
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32,189 |
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23,635 |
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Inventory |
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114,992 |
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55,608 |
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Prepaid expenses and other current assets |
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7,098 |
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4,120 |
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Prepaid research and development services |
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7,808 |
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Total current assets |
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277,098 |
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262,484 |
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Property and equipment, net |
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15,953 |
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17,044 |
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Service inventory, net |
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2,389 |
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2,986 |
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Goodwill |
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64,018 |
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65,411 |
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Deferred tax asset |
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601 |
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512 |
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Intangible assets, net |
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1,091 |
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1,181 |
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Other non-current assets |
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5,703 |
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6,284 |
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TOTAL ASSETS |
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$ |
366,853 |
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$ |
355,902 |
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LIABILITIES AND SHAREHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
65,593 |
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$ |
14,148 |
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Accrued payroll and related expenses |
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11,901 |
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12,023 |
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Advance research and development payments |
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11,621 |
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29,669 |
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Other accrued liabilities |
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8,439 |
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7,488 |
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Deferred revenue |
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37,197 |
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48,317 |
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Total current liabilities |
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134,751 |
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111,645 |
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Long-term deferred revenue |
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14,599 |
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11,745 |
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Other non-current liabilities |
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4,547 |
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4,310 |
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Convertible notes payable |
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80,000 |
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80,000 |
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TOTAL LIABILITIES |
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233,897 |
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207,700 |
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Commitments and Contingencies |
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Shareholders equity: |
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Preferred stock Authorized and
undesignated, 5,000,000 shares; no shares
issued or outstanding |
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Common stock and additional paid-in capital,
par value $.01 per share Authorized,
75,000,000 shares; issued and outstanding
33,364,934 and 32,638,415 shares,
respectively |
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516,079 |
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513,196 |
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Accumulated other comprehensive income |
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11,092 |
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13,562 |
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Accumulated deficit |
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(394,215 |
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(378,556 |
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TOTAL SHAREHOLDERS EQUITY |
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132,956 |
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148,202 |
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TOTAL LIABILITIES AND SHAREHOLDERS EQUITY |
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$ |
366,853 |
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$ |
355,902 |
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See accompanying notes
3
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands, except per share data)
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Three Months Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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2008 |
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2007 |
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2008 |
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2007 |
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Revenue: |
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Product |
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$ |
32,851 |
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$ |
13,789 |
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$ |
43,541 |
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$ |
47,449 |
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Service |
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13,882 |
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12,836 |
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29,320 |
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26,285 |
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Total revenue |
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46,733 |
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26,625 |
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72,861 |
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73,734 |
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Cost of revenue: |
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Cost of product revenue |
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22,003 |
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8,227 |
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28,415 |
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31,804 |
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Cost of service revenue |
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9,241 |
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7,660 |
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17,600 |
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15,658 |
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Total cost of revenue |
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31,244 |
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15,887 |
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46,015 |
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47,462 |
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Gross margin |
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15,489 |
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10,738 |
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26,846 |
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26,272 |
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Operating expenses: |
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Research and development, net |
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11,890 |
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8,859 |
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25,609 |
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16,739 |
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Sales and marketing |
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5,848 |
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5,123 |
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11,230 |
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10,391 |
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General and administrative |
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3,465 |
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3,822 |
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7,161 |
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8,102 |
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Restructuring and severance |
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10 |
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Total operating expenses |
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21,203 |
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17,804 |
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44,000 |
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35,242 |
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Loss from operations |
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(5,714 |
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(7,066 |
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(17,154 |
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(8,970 |
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Other income, net |
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540 |
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76 |
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793 |
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471 |
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Interest income, net |
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254 |
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966 |
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1,091 |
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1,999 |
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Loss before income taxes |
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(4,920 |
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(6,024 |
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(15,270 |
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(6,500 |
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Provision for income taxes |
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(107 |
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(360 |
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(389 |
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(725 |
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Net loss |
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$ |
(5,027 |
) |
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$ |
(6,384 |
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$ |
(15,659 |
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$ |
(7,225 |
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Basic and diluted loss per common share |
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$ |
(0.15 |
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$ |
(0.20 |
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$ |
(0.48 |
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$ |
(0.23 |
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Basic and diluted weighted average shares outstanding |
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32,521 |
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31,635 |
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32,446 |
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31,560 |
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See accompanying notes
4
CRAY INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
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Six Months Ended |
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June 30, |
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2008 |
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2007 |
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Operating activities: |
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Net loss |
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$ |
(15,659 |
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$ |
(7,225 |
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Adjustments to reconcile net loss to net cash used in operating activities: |
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Depreciation and amortization |
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5,421 |
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6,383 |
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Share-based compensation cost |
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1,378 |
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1,972 |
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Inventory write-down |
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420 |
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156 |
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Amortization of issuance costs on convertible notes payable |
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346 |
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344 |
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Deferred income taxes |
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(89 |
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(48 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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(8,893 |
) |
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19,147 |
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Inventory |
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(61,531 |
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(6,677 |
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Prepaid expenses and other current assets |
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(10,954 |
) |
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(2,561 |
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Other non-current assets |
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231 |
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(34 |
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Accounts payable |
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50,642 |
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(3,889 |
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Accrued
payroll and related expenses and other accrued liabilities |
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2,015 |
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(5,079 |
) |
Advance research and development payments |
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(18,048 |
) |
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(12,619 |
) |
Other non-current liabilities |
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234 |
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(393 |
) |
Deferred revenue |
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(8,395 |
) |
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(6,534 |
) |
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Net cash used in operating activities |
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(62,882 |
) |
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(17,057 |
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Investing activities: |
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Sales/maturities of short-term investments |
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35,549 |
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12,850 |
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Purchases of short-term investments |
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(1,673 |
) |
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(63,668 |
) |
Purchases of property and equipment |
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(1,871 |
) |
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(644 |
) |
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Net cash provided by (used in) investing activities |
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32,005 |
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(51,462 |
) |
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Financing activities: |
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Proceeds from issuance of common stock through employee stock purchase plan |
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234 |
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246 |
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Proceeds from exercise of options |
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48 |
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1,271 |
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Principal payments on capital leases |
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(31 |
) |
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Net cash provided by financing activities |
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282 |
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1,486 |
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Effect of foreign exchange rate changes on cash and cash equivalents |
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166 |
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40 |
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Net decrease in cash and cash equivalents |
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(30,429 |
) |
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(66,993 |
) |
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Cash and cash equivalents |
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Beginning of period |
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120,539 |
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|
115,328 |
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End of period |
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$ |
90,110 |
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$ |
48,335 |
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Supplemental disclosure of cash flow information: |
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Cash paid for interest |
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$ |
1,202 |
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$ |
1,200 |
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Non-cash investing and financing activities: |
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Inventory transfers to fixed assets and service inventory |
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$ |
1,727 |
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$ |
3,369 |
|
Stock issued for 401(k) match |
|
$ |
1,223 |
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|
$ |
527 |
|
See accompanying notes
5
CRAY INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 Basis of Presentation
In these Notes, Cray Inc. and its wholly-owned subsidiaries are collectively referred to as
the Company. In the opinion of management, the accompanying Condensed Consolidated Balance Sheets
and related Condensed Consolidated Statements of Operations and Statements of Cash Flows have been
prepared in accordance with accounting principles generally accepted in the United States of
America (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required
by GAAP for complete financial statements. Management believes that all adjustments (consisting of
normal recurring adjustments) considered necessary for fair presentation have been included.
Interim results are not necessarily indicative of results for a full year. The information included
in this Form 10-Q should be read in conjunction with Managements Discussion and Analysis of
Financial Condition and Results of Operations and the financial statements and notes thereto
included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2007
(the 2007 Form 10-K).
The Companys revenue, results of operations and cash balances are likely to fluctuate
significantly from quarter-to-quarter. These fluctuations are due to such factors as the high
average sales prices and limited number of sales of the Companys products, the timing of purchase
orders and product deliveries, the revenue recognition accounting policy of generally not
recognizing product revenue until customer acceptance and other contractual provisions have been
fulfilled and the timing of payments for product sales, maintenance services, government research
and development funding and purchases of inventory. Given the nature of the Companys business, its
revenue, receivables and other related accounts are likely to be concentrated among a few
customers.
During the six months ended June 30, 2008, the Company incurred a net loss of $15.7 million
and used $62.9 million of cash in operating activities. The Company had $142.3 million of working
capital as of June 30, 2008. Managements plans project that the Companys current cash resources
and cash to be generated from operations will be adequate to meet the Companys liquidity needs for
at least the next twelve months. These plans assume sales, shipment, acceptance and subsequent
collections from several large customers, as well as cash receipts on new bookings.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of Cray Inc.
and its wholly-owned subsidiaries. All material intercompany accounts and transactions have been
eliminated.
Reclassifications
Certain prior-period amounts have been reclassified to conform with the current-period
presentation. There has been no impact on previously reported net loss or shareholders equity.
Use of Estimates
Preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the amounts reported in the consolidated financial statements
and accompanying notes. These estimates are based on managements best knowledge of current events
and actions the Company may undertake in the future. Estimates are used in accounting for, among
other items, fair value determination used in revenue recognition, estimates of proportional
performance on co-funded engineering contracts and prepaid research and development services,
determination of inventory at the lower of cost or market, percentage of completion accounting,
useful lives for depreciation and amortization, determination of future cash flows associated with
impairment testing for goodwill and long-lived assets, determination of the fair value of stock
options and assessments of fair value, calculation of deferred
income tax assets, potential income tax assessments and other contingencies. The Company bases its
estimates on historical experience, current conditions and on other assumptions that it believes to
be reasonable under the circumstances. Actual results could differ materially from those estimates.
6
Note 2 Summary of New Accounting Policies
Prepaid Research and Development Services
Nonrefundable advance payments for goods or services used or rendered for future research and
development activities are deferred and amortized in accordance with EITF Issue No. 07-3,
Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research
and Development Activities (EITF 07-3). Prepaid research and development services are amortized
to research and development expense over the vendors estimated period of performance. The Company
performs an evaluation at the end of each reporting period to assess whether the anticipated
services are still expected to be rendered. In the event that the Company concludes that the
services will not be rendered in the future, any unamortized amounts will be charged to research
and development expense.
Note 3 New Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (FAS) No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities (FAS 159). FAS 159 permits entities to choose to measure many financial
instruments and certain other items at fair value. The objective is to improve financial reporting
by providing entities with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply complex hedge
accounting provisions. FAS 159 was adopted during the first quarter of 2008 and did not have any
effect on the Companys financial position or operating results.
In March 2008, the FASB issued FAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities (FAS 161). FAS 161 requires companies with derivative instruments to disclose
information that should enable financial-statement users to understand how and why a company uses
derivative instruments, how derivative instruments and related hedged items are accounted for under
FAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and how derivative
instruments and related hedged items affect a companys financial position, financial performance
and cash flows. FAS 161 is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008. The Company is
currently evaluating the impact that FAS 161 will have on its consolidated financial statements.
In May 2008, the FASB issued Staff Position No. APB 14-1, Accounting for Convertible Debt
Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement) (FSP
APB 14-1). FSP APB 14-1 states that convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement) are not addressed by paragraph 12 of Accounting
Principles Board Opinion No. 14 and that issuers of such instruments should account separately for
the liability and equity components of the instruments in a manner that will reflect the entitys
nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB
14-1 is effective for financial statements issued for fiscal years beginning after December 15,
2008, and must be applied retrospectively to all periods presented. The Company is currently
evaluating the impact that FSP ABP 14-1 will have on its consolidated financial statements.
Note 4 Earnings Per Share (EPS)
Basic EPS is computed by dividing net income available to common shareholders by the weighted
average number of common shares, excluding unvested restricted stock, outstanding during the
period. Diluted EPS is computed by dividing net income available to common shareholders by the
weighted average number of common and potential common shares outstanding during the period, which
includes the unvested restricted stock and additional shares issuable upon the assumed
exercise of stock options and of common stock purchase warrants as computed under the treasury
stock method and the assumed issuance of common shares upon conversion of the outstanding
convertible notes.
For the three and six months ended June 30, 2008 and 2007, outstanding stock options, unvested
stock grants, warrants and shares issuable upon conversion of the convertible notes were
antidilutive because of net losses and, as such, their effect has not been included in the
calculation of basic or diluted net loss per share. For the three and six month periods ended June
30, 2008, potential gross common shares of 11.8 million were antidilutive and not included in
computing diluted EPS. For the three and six month periods ended June 30, 2007, potential gross
common shares of 11.0 million were antidilutive and not included in computing diluted EPS.
7
Note 5 Comprehensive Loss
The components of comprehensive loss were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Net loss |
|
$ |
(5,027 |
) |
|
$ |
(6,384 |
) |
|
$ |
(15,659 |
) |
|
$ |
(7,225 |
) |
Unrealized net loss on available-for-sale investments |
|
|
(83 |
) |
|
|
(64 |
) |
|
|
(7 |
) |
|
|
(47 |
) |
Cash flow hedges: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized net loss on cash flow hedges |
|
|
(320 |
) |
|
|
(1,482 |
) |
|
|
(123 |
) |
|
|
(1,770 |
) |
Reclassification adjustment to revenue |
|
|
500 |
|
|
|
|
|
|
|
500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment |
|
|
485 |
|
|
|
4,025 |
|
|
|
(2,840 |
) |
|
|
4,353 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(4,445 |
) |
|
$ |
(3,905 |
) |
|
$ |
(18,129 |
) |
|
$ |
(4,689 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Note 6 Fair Value Measurements
Effective January 1, 2008, the Company implemented FAS No. 157, Fair Value Measurements (FAS
157) for its financial assets and liabilities that are remeasured and reported at fair value at
each reporting period and non-financial assets and liabilities that are remeasured and reported at
fair value at least annually. In accordance with the provisions of FSP No. FAS 157-2, Effective
Date of FASB Statement No. 157, the Company elected to defer implementation of FAS 157 as it
relates to its non-financial assets and non-financial liabilities that are recognized and disclosed
at fair value in the financial statements on a nonrecurring basis until January 1, 2009. The
adoption of FAS 157 with respect to financial assets and liabilities that are remeasured and
reported at fair value at least annually did not have an impact on the Companys financial
statements. The Company is evaluating the impact, if any, that adopting FAS 157 will have on its
non-financial assets and liabilities.
In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in
active markets for identical assets or liabilities. Fair values determined by Level 2 inputs
utilize observable inputs other than Level 1 prices, such as quoted prices for similar assets or
liabilities, quoted prices in markets that are not active or other inputs that are observable or
can be corroborated by observable market data for substantially the full term of the related assets
or liabilities. Fair values determined by Level 3 inputs are unobservable data points for the asset
or liability, and include situations where there is little, if any, market activity for the asset
or liability. The following table presents information about the Companys financial assets that
have been measured at fair value as of June 30, 2008, and indicates the fair value hierarchy of the
valuation inputs utilized to determine such fair value (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted |
|
|
Significant |
|
|
|
Fair Value |
|
|
Prices in |
|
|
Other |
|
|
|
at |
|
|
Active |
|
|
Observable |
|
|
|
June 30, |
|
|
Markets |
|
|
Inputs |
|
Description |
|
2008 |
|
|
(Level 1) |
|
|
(Level 2) |
|
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
Cash, cash equivalents and restricted cash |
|
$ |
100,110 |
|
|
$ |
100,110 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments, available-for-sale |
|
|
14,901 |
|
|
|
14,901 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets measured at fair value at June 30, 2008 |
|
$ |
115,011 |
|
|
$ |
115,011 |
|
|
$ |
|
|
Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts(1) |
|
$ |
859 |
|
|
$ |
|
|
|
$ |
859 |
|
|
|
|
|
|
|
|
|
|
|
Liabilities measured at fair value at June 30, 2008 |
|
$ |
859 |
|
|
$ |
|
|
|
$ |
859 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Included in Other accrued liabilities on the Companys Condensed Consolidated Balance
Sheets. |
As of June 30, 2008, the Companys short-term investments consisted of corporate notes and
bonds and asset-backed securities which are categorized as Level 1 in accordance with FAS 157. The
fair values of cash, cash equivalents and restricted cash are determined through market, observable
and corroborated sources.
8
Short-term Investments
As of June 30, 2008, the Companys short-term investments have been classified as
available-for-sale and consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized |
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Cost |
|
|
Unrealized |
|
|
Unrealized |
|
|
|
|
|
|
Basis |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Corporate notes and bonds |
|
$ |
11,859 |
|
|
$ |
37 |
|
|
$ |
(4 |
) |
|
$ |
11,892 |
|
Asset-backed securities |
|
|
2,994 |
|
|
|
15 |
|
|
|
|
|
|
|
3,009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total short-term investments |
|
$ |
14,853 |
|
|
$ |
52 |
|
|
$ |
(4 |
) |
|
$ |
14,901 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
No
material gains or losses were realized on sales of short-term investments for the three and six
months ended June 30, 2008. The Company uses the specific identification method to determine the
cost basis for calculating realized gains or losses. As of
June 30, 2008, the Company had no auction
rate securities in its short-term investments.
Contractual maturities for short-term investments at June 30, 2008 were as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
$ |
8,024 |
|
2009 |
|
|
6,877 |
|
|
|
|
|
|
|
$ |
14,901 |
|
|
|
|
|
Foreign Currency Derivatives
As of June 30, 2008, the Company had outstanding forward contracts which have been designated
as cash flow hedges of anticipated future cash receipts on sales contracts payable in foreign
currencies (British pound sterling, Euro and Norwegian Kroner). These contracts hedge foreign currency exposure of approximately $37.4 million. The associated cash
receipts are expected to be received between 2008 and 2010.
As of June 30, 2008
and December 31, 2007, the fair value of outstanding forward contracts totaled a loss of $859,000 and $823,000,
respectively. During the three and six months ended June 30, 2008, unrecognized net losses of $320,000 and
$123,000 were recorded to Accumulated other comprehensive income on the Companys Condensed Consolidated
Balance Sheet. Cumulative unrecognized net losses recorded as a component of Accumulated other comprehensive
income as of June 30, 2008 were approximately $900,000. In the first quarter of 2008, the Company determined
that a portion of its forward contract for Norwegian Kroner was not effective and therefore changes in fair
value of 1.5 million Norwegian Kroner are being recorded in operations until such time as that portion of the
forward contract is deemed effective. During the second quarter of 2008, the Company reclassified approximately
$500,000 of deferred foreign exchange losses from Accumulated other comprehensive income against product
revenue as revenue was recognized on the hedged transaction. During
the six month period ended June 30, 2007, the Company recorded
approximately $370,000 of foreign exchange gain as Other
Income in the accompanying Condensed Consolidated Statements of
Operations related to foreign exchange gains prior to a forward
contracts designation as an effective cash flow hedge.
Note 7 Accounts Receivable
Net accounts receivable consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Trade accounts receivable |
|
$ |
17,688 |
|
|
$ |
11,569 |
|
Unbilled receivables |
|
|
6,521 |
|
|
|
5,627 |
|
Advance billings |
|
|
8,079 |
|
|
|
6,538 |
|
|
|
|
|
|
|
|
|
|
|
32,288 |
|
|
|
23,734 |
|
Allowance for doubtful accounts |
|
|
(99 |
) |
|
|
(99 |
) |
|
|
|
|
|
|
|
Accounts receivable, net |
|
$ |
32,189 |
|
|
$ |
23,635 |
|
|
|
|
|
|
|
|
Unbilled receivables represent amounts where the Company has recognized revenue in advance of
the contractual billing terms. Advance billings represent billings made based on contractual terms
for which revenue has yet been recognized.
9
As of June 30, 2008 and December 31, 2007, accounts receivable included $18.2 million and $9.7
million, respectively, due from U.S. government agencies and customers primarily serving the U.S.
government. Of this amount, $5.6 million was unbilled at each date, based upon contractual billing
arrangements with these customers. Additionally, as of December 31, 2007, accounts receivable included $4.1 million due from another customer.
Note 8 Inventory
Inventory consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Components and subassemblies |
|
$ |
72,605 |
|
|
$ |
20,814 |
|
Work in process |
|
|
21,398 |
|
|
|
15,839 |
|
Finished goods |
|
|
20,989 |
|
|
|
18,955 |
|
|
|
|
|
|
|
|
Total |
|
$ |
114,992 |
|
|
$ |
55,608 |
|
|
|
|
|
|
|
|
As of June 30, 2008 and December 31, 2007, all finished goods inventory was located at customer
sites pending acceptance. At June 30, 2008 and December 31, 2007, three customers accounted for
$16.5 million and two customers accounted for $13.3 million of finished goods inventory,
respectively.
During the three and six months ended June 30, 2008, the Company wrote off $363,000 and
$420,000 of inventory, respectively, primarily related to scrap, excess or obsolete inventory of
the Cray XT3. During the three and six months ended June 30, 2007, the Company wrote off $8,000
and $156,000 of inventory primarily related to scrap, excess or obsolete inventory
of the Cray XT3 and Cray XD1 products, respectively.
Note 9 Deferred Revenue
Deferred revenue consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Deferred product revenue |
|
$ |
20,830 |
|
|
$ |
28,592 |
|
Deferred service revenue |
|
|
30,966 |
|
|
|
31,470 |
|
|
|
|
|
|
|
|
Total deferred revenue |
|
|
51,796 |
|
|
|
60,062 |
|
Less long-term deferred revenue |
|
|
(14,599 |
) |
|
|
(11,745 |
) |
|
|
|
|
|
|
|
Deferred revenue in current liabilities |
|
$ |
37,197 |
|
|
$ |
48,317 |
|
|
|
|
|
|
|
|
As of June 30, 2008, two customers counted for 35% of total deferred revenue and as of
December 31, 2007, two customers accounted for 51% of total deferred revenue.
Note 10 Commitments and Contingencies
Minimum contractual commitments as of June 30, 2008, were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Operating |
|
|
Development |
|
|
|
Leases |
|
|
Agreements |
|
2008 (second
half) |
|
$ |
1,825 |
|
|
$ |
25,063 |
|
2009 |
|
|
1,505 |
|
|
|
13,524 |
|
2010 |
|
|
587 |
|
|
|
2,020 |
|
2011 |
|
|
493 |
|
|
|
15,000 |
|
2012 |
|
|
278 |
|
|
|
15,000 |
|
Thereafter |
|
|
1,191 |
|
|
|
|
|
|
|
|
|
|
|
|
Minimum contractual commitments |
|
$ |
5,879 |
|
|
$ |
70,607 |
|
|
|
|
|
|
|
|
10
Note 11 Share-Based Compensation
The Company accounts for its share-based compensation under the provisions of FASB Statement
No. 123(R), Share-Based Payment (FAS 123R).
The fair value of unvested restricted stock grants is based on the price of a share of the
Companys common stock on the date of grant. In determining fair value of stock options, the
Company uses the Black-Scholes option pricing model and employed the following key weighted average
assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Risk-free interest rate |
|
|
2.9% |
|
|
|
4.7% |
|
|
|
2.8% |
|
|
|
4.7% |
|
Expected dividend yield |
|
|
0% |
|
|
|
0% |
|
|
|
0% |
|
|
|
0% |
|
Volatility |
|
|
69% |
|
|
|
73% |
|
|
|
69% |
|
|
|
73% |
|
Expected life |
|
4.0 years |
|
|
4.0 years |
|
|
4.0 years |
|
|
4.0 years |
|
|
Weighted average Black-Scholes value of options granted |
|
$ |
3.57 |
|
|
$ |
4.57 |
|
|
$ |
3.52 |
|
|
$ |
6.28 |
|
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of
grant. The Company does not anticipate declaring dividends in the foreseeable future. Volatility is
based on historical data. The expected life of an option is based on the assumption that options
will be exercised, on average, about two years after vesting occurs. FAS 123R also requires that
the Company recognize compensation expense for only the portion of options or stock units that are
expected to vest. Therefore, management applies an estimated forfeiture rate that is derived from
historical employee termination data and adjusted for expected future employee turnover rates. The
estimated forfeiture rate for the three and six month periods ended June 30, 2008, was 9% for each period, and 5%
and 9% for the three and six months ended June 30, 2007, respectively. If the actual number of
forfeitures differs from those estimated by management, additional adjustments to compensation
expense may be required in future periods. The Companys stock price volatility, option lives and
expected forfeiture rates involve managements best estimates at the time of such determination,
all of which impact the fair value of the option calculated under the Black-Scholes methodology
and, ultimately, the expense that will be recognized over the life of the option. The Company
typically issues stock options with a four-year vesting period (defined by FAS 123R as the
requisite service period). The Company amortizes stock compensation cost ratably over the requisite
service period.
The Company also has an employee stock purchase plan (ESPP) which allows employees to
purchase shares of the Companys common stock at 95% of fair market value on the fourth business
day after the end of each offering period. The ESPP is deemed non-compensatory and therefore is not
subject to the provisions of FAS 123R.
The following table sets forth the gross share-based compensation cost resulting from stock
options and unvested restricted stock grants that was recorded in the Companys Condensed
Consolidated Statements of Operations for the three and six month periods ended June 30, 2008 and
2007 (in thousands):
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Cost of product revenue |
|
$ |
23 |
|
|
$ |
28 |
|
|
$ |
37 |
|
|
$ |
55 |
|
Cost of service revenue |
|
|
43 |
|
|
|
46 |
|
|
|
69 |
|
|
|
87 |
|
Research and development, net |
|
|
296 |
|
|
|
302 |
|
|
|
517 |
|
|
|
644 |
|
Sales and marketing |
|
|
128 |
|
|
|
136 |
|
|
|
209 |
|
|
|
273 |
|
General and administrative |
|
|
315 |
|
|
|
438 |
|
|
|
546 |
|
|
|
913 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
805 |
|
|
$ |
950 |
|
|
$ |
1,378 |
|
|
$ |
1,972 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A summary of the Companys year-to-date stock option activity and related information follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
Weighted |
|
Average |
|
|
|
|
|
|
|
|
Average |
|
Remaining |
|
Aggregate |
|
|
|
|
|
|
Exercise |
|
Contractual |
|
Intrinsic |
|
|
Options |
|
Price |
|
Term |
|
Value |
Outstanding at December 31, 2007 |
|
|
3,328,798 |
|
|
$ |
14.68 |
|
|
|
|
|
|
|
|
|
Grants |
|
|
881,350 |
|
|
|
6.54 |
|
|
|
|
|
|
|
|
|
Exercises |
|
|
(8,072 |
) |
|
|
5.96 |
|
|
|
|
|
|
|
|
|
Cancellations |
|
|
(180,694 |
) |
|
|
19.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2008 |
|
|
4,021,382 |
|
|
$ |
12.72 |
|
|
6.7 years |
|
$ |
98,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June 30, 2008 |
|
|
2,680,572 |
|
|
$ |
15.18 |
|
|
5.4 years |
|
$ |
98,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for grant at June 30, 2008 |
|
|
1,435,425 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value in the table above represents the total pretax intrinsic value
for all in-the-money options (i.e., the difference between the Companys closing stock price on
the last trading day of its second quarter of 2008 and the exercise price, multiplied by the number
of shares) that would have been received by the option holders had all option holders exercised
their options on June 30, 2008. For the three and six months ended June 30, 2008, options exercised
totaled 8,072 shares, with a total intrinsic value of $2,000. Total intrinsic value of options
exercised was $196,000 and $877,000 for the three and six months ended June 30, 2007, respectively.
A summary of the Companys unvested restricted stock grants and changes during the period
ended June 30, 2008 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Average |
|
|
Shares |
|
Grant date Fair Value |
|
|
|
|
|
Outstanding at January 1, 2008 |
|
|
376,206 |
|
|
$ |
9.82 |
|
Granted |
|
|
451,135 |
|
|
|
6.41 |
|
Forfeited |
|
|
(3,200 |
) |
|
|
10.56 |
|
Vested |
|
|
(52,406 |
) |
|
|
7.58 |
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2008 |
|
|
771,735 |
|
|
$ |
12.73 |
|
|
|
|
|
|
|
|
|
|
For the three and six months ended June 30, 2008, 386,135 and 451,135 shares of unvested
restricted stock, respectively were granted by the Company.
As of June 30, 2008, the Company had $10.5 million of total unrecognized compensation cost
related to unvested stock options and unvested restricted stock grants, which is expected to be
recognized over a weighted average period of 3.0 years.
Note 12 Taxes
The Company recorded a tax provision of $107,000 and $389,000 for the three and six months
ended June 30, 2008, respectively, and $360,000 and $725,000 for the three and six month periods
ended June 30, 2007, respectively. The expense recorded for all periods was
primarily related to foreign income taxes payable.
The Company continues to provide a full valuation allowance against net operating losses and
other net deferred tax assets arising in certain jurisdictions, primarily in the United States and
Canada, as the realization of such assets is not considered to be more likely
12
than not. In March
2008, Cray UK Limited, a wholly-owned subsidiary of the Company, received notice from HM
Revenue
& Customs, which is the United Kingdom equivalent of the Internal Revenue Service, of its
intent to open an inquiry into Cray UK Limiteds 2005 and 2006 corporate income tax returns. At
this time, it is not possible to determine the extent or the outcome of such inquiry.
Note 13 Geographic Segment Information
FAS No. 131, Disclosure about Segments of an Enterprise and Related Information (FAS 131),
establishes standards for reporting information about operating segments and for related
disclosures about products, services and geographic areas. Operating segments are identified as
components of an enterprise about which separate discrete financial information is available for
evaluation by the chief operating decision-maker, or decision-making group, in making decisions
regarding allocation of resources and assessing performance. Crays chief decision-maker, as
defined under FAS 131, is the Chief Executive Officer. The Company continues to operate in a single
operating segment.
The Companys geographic operations outside the United States include sales and service
offices in Canada, Europe, the Middle East, Japan, Australia, Korea and Taiwan. The following data
presents the Companys revenue for the United States and all other countries, which is determined
based upon a customers geographic location (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
|
Other Countries |
|
|
Total |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Three months ended June 30, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue |
|
$ |
21,760 |
|
|
$ |
9,327 |
|
|
$ |
11,091 |
|
|
$ |
4,462 |
|
|
$ |
32,851 |
|
|
$ |
13,789 |
|
Service revenue |
|
|
7,994 |
|
|
|
7,824 |
|
|
|
5,888 |
|
|
|
5,012 |
|
|
|
13,882 |
|
|
|
12,836 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
$ |
29,754 |
|
|
$ |
17,151 |
|
|
$ |
16,979 |
|
|
$ |
9,474 |
|
|
$ |
46,733 |
|
|
$ |
26,625 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
|
Other Countries |
|
|
Total |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Six months ended June 30, |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue |
|
$ |
31,544 |
|
|
$ |
34,540 |
|
|
$ |
11,997 |
|
|
$ |
12,909 |
|
|
$ |
43,541 |
|
|
$ |
47,449 |
|
Service revenue |
|
|
17,524 |
|
|
|
16,428 |
|
|
|
11,796 |
|
|
|
9,857 |
|
|
|
29,320 |
|
|
|
26,285 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
$ |
49,068 |
|
|
$ |
50,968 |
|
|
$ |
23,793 |
|
|
$ |
22,766 |
|
|
$ |
72,861 |
|
|
$ |
73,734 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product and service revenue from U.S. government agencies and customers primarily serving the
U.S. government totaled approximately $28.2 million and $41.3 million, respectively, for the three and six months
ended June 30, 2008, compared to approximately $17.0 million and $50.3 million, respectively for the
three and six months ended June 30, 2007.
There has been no material change in the balances of long-lived assets, except for the impact
of foreign currency translation on goodwill.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Preliminary Note Regarding Forward-Looking Statements
The information set forth in Managements Discussion and Analysis of Financial Condition and
Results of Operations below contains forward-looking statements that involve risks and
uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could
cause our actual results to differ materially from those expressed or implied by such
forward-looking statements. All statements other than statements of historical fact are statements
that could be deemed forward-looking statements, including any projections of earnings, revenue or
other financial items; any statements of the plans, strategies and objectives of management for
future operations; any statements concerning proposed new products, services or developments; any
statements regarding future economic conditions or performance; any statements of belief and any
statement of assumptions underlying any of the foregoing. We assume no obligation to update these
forward-looking statements. These forward-looking statements are subject to the safe harbor created
by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Factors that could cause our actual results to differ materially
from those expressed or implied in the forward-looking statements are set forth in the discussion
under Item 1A. Risk Factors in Part II of this Report. The following discussion should also
13
be read in conjunction with the Consolidated Financial Statements and accompanying Notes
thereto in our 2007 Form 10-K and the Condensed Consolidated Financial Statements and accompanying
Notes thereto in this Report.
Overview and Executive Summary
We design, develop, manufacture, market and service high performance computing (HPC)
systems, commonly known as supercomputers. Our supercomputer systems provide capability, capacity
and sustained performance far beyond typical server-based computer systems and address challenging
scientific and engineering computing problems.
We believe we are well-positioned to meet the demanding needs of the high-end of the HPC
market by providing superior supercomputer systems with performance and cost advantages when
sustained performance on challenging applications and total cost of ownership are taken into
account. We differentiate ourselves from our competitors primarily by concentrating our research
and development efforts on the processing, interconnect and system capabilities that enable our
supercomputers to scale that is, to continue to increase performance as they grow in size. In
addition, we have demonstrated expertise in several processor technologies. Purpose-built for the
supercomputer market, our systems balance highly capable processors, highly scalable system
software and very high speed interconnect and communications capabilities.
Summary of First Half of 2008 Results
Total
revenue for the first six months of 2008 decreased $0.9 million or 1% compared to the
first six months of 2007 due to lower product revenue of $3.9 million offset by higher service
revenue of $3.0 million.
Loss from operations was $17.2 million for the first six months of 2008 compared to a loss
from operations of $9.0 million for the first six months of 2007 due to higher operating expenses,
driven predominately by increased net research and development expense.
Net cash used in operations for the first six months of 2008 was $62.9 million compared to net
cash used in operations of $17.1 million for the first six months of 2007. The net cash use was
largely driven by a build-up in inventory to support second half 2008 customer shipments. Cash and
cash equivalents, restricted cash and short-term investments totaled $115.0 million as of June 30,
2008 compared to $179.1 million as of December 31, 2007.
Market Overview and Challenges
In recent years the most significant trend in the HPC market has been the expansion and
acceptance of low-bandwidth cluster systems using processors manufactured by Intel, AMD, IBM and
others with commercially available commodity networking and other components throughout the HPC
market, especially in capacity computing situations. These systems may offer higher theoretical
peak performance for equivalent cost, and vendors of such systems often put pricing pressure on us
in competitive procurements, even at times in capability market procurements.
In the capability market and in large capacity procurements in the enterprise market, the use
of commodity processors and networking components is resulting in increasing data transfer
bottlenecks as these components do not balance faster processor speeds with network communication
capability. With the arrival of dual and quad-core processors, these unbalanced systems have even
lower productivity, especially in larger systems running more complex applications, a trend that is
likely to increase with the arrival of ever larger multi-core processors in future years. In
response, vendors have begun to augment standard microprocessors with other processor types in
order to solve complex problems faster. In addition, with increasing numbers of multi-core
processors, large computer systems use progressively higher amounts of power to operate and require
special cooling capabilities.
We believe we are well-positioned to meet the markets demanding needs, as we concentrate our
research and development efforts on the processing, interconnect, system software and packaging
capabilities that enable our supercomputers to perform at scale. We have demonstrated expertise in
several processor technologiesmassively parallel processing, vector processing multithreading and
co-processing with field programmable gate arrays. Further, we offer unique capabilities in high-speed, high bandwidth
interconnect design, system software and packaging capabilities. Our experience and capabilities
across each of these fronts are becoming ever more important, especially in larger procurements. We
expect to be in a comparatively advantageous position as larger multi-core processors become
available and as multiple processing technologies become integrated into single systems.
14
To compete against cluster systems in the longer term, we need to continue to incorporate
performance differentiation across our products. We provide significant performance differentiation
with our high-bandwidth, massively parallel commodity processor-based products, such as our Cray
XT4, Cray XT5 and successor systems, along with our processor differentiated products such as the
Cray XT5h and Cray XMT systems.
Our Goals and Strategy
Our goals are to become the leading provider of supercomputers in the HPC markets that we
target and to have sustained annual profitability. Key elements of our strategy to achieve these
goals include:
Gain Share in Our Core HPC Market. We intend to leverage our strong product portfolio, product
roadmap and brand recognition in the high end of the HPC market to gain market share. We believe
that most of our competitors are primarily focused on the lower end of the HPC market where
low-bandwidth cluster systems dominate. We plan to remain focused primarily on the high-end
supercomputing segment of the HPC market.
Extend Technology Leadership. We are an innovation driven company in a technology driven
market. We plan to maintain a technology leadership position by investing in research and
development and partnering with key suppliers as well as customers with interests strongly aligned
with ours. We will rely in part on government funding for our research and development efforts. We
intend to execute on our product roadmap, supporting multiple processing technologies within
single, highly scalable systems.
Expand Our Total Addressable Market. Over time, we intend to expand our addressable market by
leveraging our technologies, customer base, Cray brand and industry trends by introducing
complementary products and services to new and existing customers. We believe we have the
opportunity to compete in a broader portion of the HPC market as well as selective adjacent markets
outside of traditional HPC.
Maintain Our Focus on Execution and Profitability. We are committed to achieving sustained
profitability on an annual basis. We intend to continue to refine our product roadmap, converge our
technologies and development processes, improve our ability to deliver high quality products on
time and on budget and continue our commitment to financial discipline.
We believe our April 2008 collaboration with Intel is in line with each of these strategies as
in the future we will be able to provide the HPC market with access to the best processors that are
available at any point in time.
Key Performance Indicators
Our management monitors and analyzes several key performance indicators in order to manage our
business and evaluate our financial and operating performance, including:
Revenue. Product revenue generally constitutes the major portion of our revenue in any
reporting period and, for the reasons discussed elsewhere in this Quarterly Report on Form 10-Q, is
subject to significant variability from period to period. In the short term, we closely review the
status of product shipments, installations and acceptances in order to forecast revenue and cash
receipts; longer-term, we monitor the status of the pipeline of product sales opportunities and
product development cycles. Revenue growth is the best indicator of whether we are achieving our
objective of increased market share in the markets we address. The introduction of the quad-core
Cray XT4 system and the Cray XT5 family and our longer-term product roadmap, including our
collaboration with Intel, are efforts to increase product revenue. We expect that product revenue
will increase significantly in 2008 over 2007 due to the forecasted acceptance of a petaflops
(1,000 trillion floating point operations per second) supercomputer in late 2008. We also plan to
increase our Cray Technical Services offerings to increase revenue. Maintenance service revenue is
more constant in the short term and assists, in part, to offset the impact that the variability in
product revenue has on total revenue.
Gross margins. Our total gross margin and our product gross margin for the first six months of
2008 were 37% and 35%, respectively, slight increases from the respective 2007 levels of 36% and
33%. Total gross margin for first half of 2008 was favorably impacted by a high margin,
nonrecurring Cray Technical Services project that concluded in the first quarter of 2008. We need
to continue to maintain and improve our product gross margins, which we believe is best achieved
through product differentiation.
15
Operating expenses. Our operating expenses are driven largely by headcount, contracted
research and development services and the level of recognized co-funding for research and
development. As part of our ongoing efforts to control operating expenses, we monitor headcount
levels in specific geographic and operational areas. Our November 2006 DARPA Phase III award is in
line with our long-term development path. This award, however, likely will result in increases in
gross and net research and development expenditures by us in future periods due to the size of the
overall program and the cost-sharing requirement on our part. Our operating expenses for the first
six months of 2008 were approximately $8.8 million greater than the corresponding 2007 period,
driven largely by higher net research and development expenses in 2008 resulting from lower amounts
recognized from government co-funding arrangements.
Liquidity and cash flows. Due to the variability in product revenue, our cash position also
varies from quarter to quarter and within a quarter. We closely monitor our expected cash levels,
particularly in light of increased inventory purchases for large system installations and the risk
of delays in product shipments and acceptances and, longer-term, in product development. Sustained
profitability over annual periods is our primary objective, which should improve our cash position
and shareholder value.
Critical Accounting Policies and Estimates
This discussion, as well as disclosures included elsewhere in this Quarterly Report on Form
10-Q, is based upon our condensed consolidated financial statements, which have been prepared in
accordance with GAAP. The preparation of these financial statements requires us to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and
related disclosure of contingencies. In preparing our financial statements in accordance with GAAP,
there are certain accounting policies that are particularly important. These include revenue
recognition, inventory valuation, goodwill, accounting for income taxes, accounting for loss
contracts, research and development expenses and share-based compensation. Our relevant accounting
policies are set forth in Note 2 to the Consolidated Financial Statements included in our 2007 Form
10-K and should be reviewed in conjunction with the accompanying condensed consolidated financial
statements and notes thereto as of June 30, 2008, as they are integral to understanding our results
of operations and financial condition in this interim period. In some cases, these policies
represent required accounting. In other cases, they may represent a choice between acceptable
accounting methods or may require substantial judgment or estimation.
Additionally, we consider certain judgments and estimates to be significant, including those
relating to the fair value determination used in revenue recognition, percentage of completion
accounting, estimates of proportional performance on co-funded
engineering contracts and prepaid research and development services, determination of inventory at the lower of cost or market, useful lives for
depreciation and amortization, determination of future cash flows associated with impairment
testing for goodwill and long-lived assets, determination of the fair value of stock options and
other assessments of fair value, calculation of deferred income tax
assets, potential income tax assessments and other contingencies. We base our estimates on
historical experience, current conditions and on other assumptions that we believe to be reasonable
under the circumstances. Actual results may differ materially from these estimates and assumptions.
Our management has discussed the selection of significant accounting policies and the effect
of judgments and estimates with the Audit Committee of our Board of Directors.
Revenue Recognition
We recognize revenue when it is realized or realizable and earned. In accordance with the
Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition
in Financial Statements, we consider revenue realized or realizable and earned when we have
persuasive evidence of an arrangement, the product has been shipped or the services have been
provided to our customer, the sales price is fixed or determinable, no significant unfulfilled
obligations exist and collectibility is reasonably assured. We record revenue in our Consolidated
Statements of Operations net of any sales, use, value added or certain excise taxes imposed by
governmental authorities on specific sales transactions. In addition to the aforementioned general
policy, the following are our statements of policy with regard to multiple-element arrangements and
specific revenue recognition policies for each major category of revenue.
Multiple-Element Arrangements. We commonly enter into transactions that include
multiple-element arrangements, which may include any combination of hardware, maintenance and other
services. In accordance with Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with
Multiple Deliverables, when some elements are delivered prior to others in an arrangement and all
of the following criteria are met, revenue for the delivered element is recognized upon delivery
and acceptance of such item:
16
|
|
|
The element could be sold separately; |
|
|
|
|
The fair value of the undelivered element is established; and |
|
|
|
|
In cases with any general right of return, our performance with respect to any
undelivered element is within our control and probable. |
If all of the criteria are not met, revenue is deferred until delivery of the last element as
the elements would not be considered a separate unit of accounting and revenue would be recognized
as described below under our product or service revenue recognition policies. We consider the
maintenance period to commence upon acceptance of the product, which may include a warranty period
and accordingly allocate a portion of the sales price as a separate deliverable which is recognized
as service revenue over the entire service period.
Products. We recognize revenue from product sales upon customer acceptance of the system, when
we have no significant unfulfilled obligations stipulated by the contract that affect the
customers final acceptance, the price is fixed or determinable and collection is reasonably
assured. A customer-signed notice of acceptance or similar document is typically required from the
customer prior to revenue recognition.
Project Revenue. Revenue from contracts that require us to design, develop, manufacture or
modify complex information technology systems to a customers specifications is recognized using
the percentage of completion method for long-term development projects under American Institute of
Certified Public Accountants (AICPA) Statement of Position 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts. Percentage of completion is measured based
on the ratio of costs incurred to date compared to the total estimated costs. Total estimated costs
are based on several factors, including estimated labor hours to complete certain tasks and the
estimated cost of purchased components or services. Estimates may need to be adjusted from quarter
to quarter, which would impact revenue and margins on a cumulative basis. To the extent the
estimate of total costs to complete the contract indicates a loss, such amount is recognized in
full in the period that the determination is made.
Services. Maintenance services are provided under separate maintenance contracts with our
customers. These contracts generally provide for maintenance services for one year, although some
are for multi-year periods, often with prepayments for the term of the contract. We consider the
maintenance period to commence upon acceptance of the product, which may include a warranty period.
We allocate a portion of the sales price to maintenance service revenue based on estimates of fair
value. Revenue for the maintenance of computers is recognized ratably over the term of the
maintenance contract. Maintenance contracts that are paid in advance are recorded as deferred
revenue. We consider fiscal funding clauses as contingencies for the recognition of revenue until
the funding is virtually assured. Revenue from Cray Technical Services is recognized as the
services are rendered.
Inventory Valuation
We record our inventory at the lower of cost or market. We regularly evaluate the
technological usefulness and anticipated future demand of our inventory components. Due to rapid
changes in technology and the increasing demands of our customers, we are continually developing
new products. Additionally, during periods of product or inventory component upgrades or
transitions, we may acquire significant quantities of inventory to support estimated current and
future production and service requirements. As a result, it is possible that older inventory items
we have purchased may become obsolete, be sold below cost or be deemed in excess of quantities
required for production or service requirements. When we determine it is not likely we will recover
the cost of inventory items through future sales, we write down the related inventory to our
estimate of its market value.
Because the products we sell have high average sales prices and because a high number of our
prospective customers receive funding from U.S. or foreign governments, it is difficult to estimate
future sales of our products and the timing of such sales. It also is difficult to determine
whether the cost of our inventories will ultimately be recovered through future sales. While we
believe our inventory is stated at the lower of cost or market and that our estimates and
assumptions to determine any adjustments to the cost of our inventories are reasonable, our
estimates may prove to be inaccurate. We have sold inventory previously reduced in part or in whole
to zero, and we may have future sales of previously written-down inventory. We also may have
additional expense to write down inventory to its estimated market value. Adjustments to these
estimates in the future may materially impact our operating results.
17
Goodwill
Approximately 17% of our total assets as of June 30, 2008 consisted of goodwill resulting from
our acquisition of the Cray Research business unit assets from Silicon Graphics, Inc. in 2000 and
our acquisition of OctigaBay Systems Corporation in 2004. We no longer amortize goodwill associated
with these acquisitions, but we are required to conduct periodic analyses of the recorded amount of
goodwill in comparison to its estimated fair value. We currently have one operating segment and
reporting unit. As such, we evaluate any potential goodwill impairment by comparing our net assets
against the market value of our outstanding shares of common stock. We performed an annual
impairment test effective January 1, 2008, and determined that our recorded goodwill was not
impaired, and we continue to monitor possible goodwill impairment on
an ongoing basis.
The analysis of whether the fair value of recorded goodwill is impaired and the number and
nature of our reporting units involves a substantial amount of judgment. Future charges related to
the amounts recorded for goodwill could be material depending on future developments and changes in
technology and our business.
Accounting for Income Taxes
Deferred tax assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and operating loss and tax credit carryforwards
and are measured using the enacted tax rates and laws that will be in effect when the differences
and carryforwards are expected to be recovered or settled. In accordance with FAS No. 109,
Accounting for Income Taxes, a valuation allowance for deferred tax assets is provided when we
estimate that it is more likely than not that all or a portion of the deferred tax assets may not
be realized through future operations. This assessment is based upon consideration of available
positive and negative evidence, which includes, among other things, our most recent results of
operations and expected future profitability. We consider our actual historical results to have
stronger weight than other more subjective indicators when considering whether to establish or
reduce a valuation allowance on deferred tax assets. Estimated interest and penalties are recorded
as a component of interest expense and other expense, respectively.
As of June 30, 2008, we had approximately $139.5 million of deferred tax assets, against which
we provided a $138.9 million valuation allowance. Our net deferred tax assets were generated in
foreign jurisdictions where we believe it is more likely than not that we will realize these assets
through future operations.
Accounting for Loss Contracts
In accordance with our revenue recognition policy, certain production contracts are accounted
for using the percentage of completion accounting method. We recognize revenue based on a
measurement of completion comparing the ratio of costs incurred to date with total estimated costs
multiplied by the contract value. Inherent in these estimates are uncertainties about the total
cost to complete the project. If the estimate to complete results in a loss on the contract, we
will record the amount of the estimated loss in the period the determination is made. On a regular
basis, we update our estimates of total costs. Changes to the estimate may result in a charge or
benefit to operations.
As of June 30, 2008, our estimate of cumulative loss on the Red Storm contract totaled $15.5
million, which was consistent with December 31, 2007. As of June 30, 2008 and December 31, 2007,
the Red Storm accrued contract loss liability balance was $1.3 million and is included in Other
accrued liabilities in our Condensed Consolidated Balance Sheets.
Research and Development Expenses
Research and development costs include costs incurred in the development and production of our
systems, costs incurred to enhance and support existing features and expenses related to future
product development. Research and development costs are expensed as incurred, and may be offset by
co-funding from the U.S. government or other parties. We enter into arrangements whereby we make
advance, non-refundable payments to a vendor. These payments are deferred and recognized over the
vendors estimated performance.
Amounts to be received under co-funding arrangements with the U.S. government are based on
either contractual milestones or costs incurred depending on the specific terms of the arrangement.
These co-funding milestone payments are recognized in operations
18
as performance is estimated to be completed and are measured as milestone achievements occur
or as costs are incurred. These estimates are reviewed on a periodic basis and are subject to
change, including in the near term. If an estimate is changed, net research and development expense
could be impacted significantly. Funding under DARPA Phase III is reflected as reimbursed research
and development expense, and as such is deducted to arrive at net research and development expenses
in our Condensed Consolidated Statements of Operations.
We do not record a receivable from the U.S. government prior to completing the requirements
necessary to bill for a milestone or cost reimbursement. Funding from the U.S. government is
subject to certain budget restrictions and milestones may be subject to completion risk, and as
such, there may be periods in which research and development costs are expensed as incurred for
which no reimbursement is recorded, as milestones have not been completed or the U.S. government
has not funded an agreement.
We classify amounts to be received from funded research and development projects as either
revenue or a reduction to research and development expense, based on the specific facts and
circumstances of the contractual arrangement, considering total costs expected to be incurred
compared to total expected funding and the nature of the research and development contractual
arrangement. In the event that a particular arrangement is determined to represent revenue, the
corresponding research and development costs are classified as cost of revenue.
Share-based Compensation
We account for share-based compensation in accordance with the provisions of FAS 123R.
Estimates of fair value of stock options are based upon the Black-Scholes option pricing model. We
utilize assumptions related to stock price volatility, stock option term and forfeiture rates that
are based upon both historical factors as well as managements judgment.
New Accounting Pronouncements
Effective January 1, 2008, we implemented FAS No. 157, Fair Value Measurement (FAS 157), for
our financial assets and liabilities that are remeasured and reported at fair value at each
reporting period, and non-financial assets and liabilities that are remeasured and reported at
fair value at least annually. In accordance with the provisions of FSP No. FAS 157-2, Effective
Date of FASB Statement No. 157, we elected to defer implementation of FAS 157 as it relates to our
non-financial assets and non-financial liabilities that are recognized and disclosed at fair value
in the financial statements on a nonrecurring basis until January 1, 2009. We are evaluating the
impact, if any, adopting FAS 157 will have on our non-financial assets and liabilities.
In February 2007, the FASB issued FAS No. 159,
which permits entities to choose to measure many financial
instruments and certain other items at fair value. The objective is to improve financial reporting
by providing entities with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply complex hedge
accounting provisions. This statement was adopted during the first quarter of 2008 and did not have
any effect on our financial position or operating results.
In March 2008, the FASB issued FAS No. 161,
which requires companies with derivative instruments to disclose
information that should enable financial-statement users to understand how and why a company uses
derivative instruments, how derivative instruments and related hedged items are accounted for under
FAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and how derivative
instruments and related hedged items affect a companys financial position, financial performance
and cash flows. FAS 161 is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008. We are currently evaluating the impact, if any, that FAS
161 will have on our consolidated financial statements.
In May 2008, the FASB issued Staff Position No. APB 14-1,
which
states that convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement) are not addressed by paragraph 12 of Accounting
Principles Board Opinion No. 14 and that issuers of such instruments should account separately for
the liability and equity components of the instruments in a manner that will reflect the entitys
nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB
14-1 is effective for financial statements issued for fiscal years beginning after December 15,
2008, and must be applied retrospectively to all periods presented. We are currently evaluating the
impact that FSP APB 14-1 will have on our consolidated financial statements.
19
Results of Operations
Revenue and Gross Margins
Our revenue, cost of revenue and gross margin for the three and six months ended June 30, 2008
and 2007 were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Product revenue |
|
$ |
32,851 |
|
|
$ |
13,789 |
|
|
$ |
43,541 |
|
|
$ |
47,449 |
|
Less: Cost of product revenue |
|
|
22,003 |
|
|
|
8,227 |
|
|
|
28,415 |
|
|
|
31,804 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product gross margin |
|
$ |
10,848 |
|
|
$ |
5,562 |
|
|
$ |
15,126 |
|
|
$ |
15,645 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product gross margin percentage |
|
|
33% |
|
|
|
40% |
|
|
|
35% |
|
|
|
33% |
|
|
Service revenue |
|
$ |
13,882 |
|
|
$ |
12,836 |
|
|
$ |
29,320 |
|
|
$ |
26,285 |
|
Less: Cost of service revenue |
|
|
9,241 |
|
|
|
7,660 |
|
|
|
17,600 |
|
|
|
15,658 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service gross margin |
|
$ |
4,641 |
|
|
$ |
5,176 |
|
|
$ |
11,720 |
|
|
$ |
10,627 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service gross margin percentage |
|
|
33% |
|
|
|
40% |
|
|
|
40% |
|
|
|
40% |
|
|
Total revenue |
|
$ |
46,733 |
|
|
$ |
26,625 |
|
|
$ |
72,861 |
|
|
$ |
73,734 |
|
Less: Total cost of revenue |
|
|
31,244 |
|
|
|
15,887 |
|
|
|
46,015 |
|
|
|
47,462 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross margin |
|
$ |
15,489 |
|
|
$ |
10,738 |
|
|
$ |
26,846 |
|
|
$ |
26,272 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross margin percentage |
|
|
33% |
|
|
|
40% |
|
|
|
37% |
|
|
|
36% |
|
Product Revenue
Product revenue for the three and six months ended June 30, 2008,
consisted of $32.9 million
and $43.5 million, respectively, primarily from quad-core Cray XT4, Cray XT5h vector
systems and other products, including the Cray XMT massively
multithreaded system, in the second quarter.
Product revenue for the three and six months ended June 30, 2007, consisted of $13.8 million and
$47.4 million, respectively, principally from Cray XT4, Cray XT3, Cray XD1 and
Cray X1E systems and other products. We recognized no revenue from the Red Storm development
project in any of these periods.
For 2008, while there is a wide range of potential outcomes, we anticipate that
total revenue will be in the range of $280 million, weighted heavily toward the fourth quarter
of the year. Among other variables, this outlook depends substantially on the acceptance of the Oakridge National Laboratory
petaflops (1,000 trillion floating point operations per second) supercomputer late in the year, which is anticipated to contribute about $90 million in product revenue.
For the remainder of 2008, quarterly and
annual results will be affected by many factors, including the timing and success of planned
product rollouts, the availability of qualified parts from suppliers, the timing of customer
acceptances, revenue recognition and the level of margin contribution.
Service Revenue
Service revenue for the three months ended June 30, 2008, was $13.9 million compared to $12.8
million for the same period in 2007, due to increased Cray Technical Services
revenue. Service revenue for the six months ended June 30, 2008 was $29.3 million compared to
$26.3 million for the same period in 2007 primarily due to higher Cray Technical Services revenue,
which included a nonrecurring project that was completed in the first quarter.
We expect that our overall service revenue will increase in 2008 from 2007 levels due to
higher maintenance and Cray Technical Service revenue. While we expect our maintenance service
revenue to stabilize over the next year, we may have periodic revenue and
20
margin declines as our older, higher margin service contracts end. Our newer products will
likely require less hardware maintenance and therefore generate less maintenance revenue than our
historic vector systems.
Product Gross Margin
Product gross margin declined 7 percentage points to 33 percent for the three-month period
ended June 30, 2008 compared to the same period in 2007; product margins were very high in the 2007
period across a smaller product revenue total. In addition, product margins in the 2008 period
were impacted negatively by a penalty from a late customer acceptance due to supplier delays and
sales of lower margin third party equipment. Product gross margin improved 2 percentage points to
35 percent for the six-month period ended June 30, 2008 compared to the 2007 period due to
increased margins across all current products, which included initial revenue from the Cray
XT5h and Cray XMT systems in 2008.
For 2008, we expect overall product gross margin to be consistent with 2007 levels, with
significant fluctuations on a quarter-to-quarter basis.
Service Gross Margin
Service gross margin for the three month period ended June 30, 2008 decreased 7 percentage
points to 33 percent compared to the respective 2007 period primarily due to higher personnel
costs, due in part to the expansion of Cray Technical Services
offerings, and a delay in a
maintenance contract renewal (subsequently received), which together more than offset a $1 million
increase in Technical Services revenue. Service gross margin for the six-month period ended June
30, 2008 of 40 percent was comparable to the margin for the same period in 2007.
For 2008, we expect service
gross margin percentage to decrease somewhat from 2007 levels, although gross margin contribution should
increase with an increase in Cray Technical Services revenue offset somewhat by additional costs
associated with expanding these offerings.
Research and Development Expenses
Our research and development expenses for the three and six months ended June 30, 2008 and
2007, were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Gross research and development expenses |
|
$ |
22,215 |
|
|
$ |
21,652 |
|
|
$ |
44,307 |
|
|
$ |
44,183 |
|
Less: Amounts included in cost of product revenue |
|
|
|
|
|
|
(195 |
) |
|
|
|
|
|
|
(465 |
) |
Less: Reimbursed research and development
(excludes amounts in revenue) |
|
|
(10,325 |
) |
|
|
(12,598 |
) |
|
|
(18,698 |
) |
|
|
(26,979 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net research and development expenses |
|
$ |
11,890 |
|
|
$ |
8,859 |
|
|
$ |
25,609 |
|
|
$ |
16,739 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of total revenue |
|
|
25% |
|
|
|
33% |
|
|
|
35% |
|
|
|
23% |
|
Gross research and development expenses in the table above reflect all research and
development expenditures, including expenses related to our research and development activities on
the Red Storm and DARPA Phase III projects. Research and development expenses on the Red Storm
project are reflected in our Condensed Consolidated Statements of Operations as cost of product
revenue, and government co-funding on our other projects, including DARPA Phase III, is recorded in
our Condensed Consolidated Statements of Operations as reimbursed research and development.
Research and development expenses included personnel expenses, depreciation, allocations for
certain overhead expenses, software, prototype materials and outside contracted engineering
expenses.
For the three and six months ended June 30, 2008, net research and development expenses increased
as compared to the same periods in 2007, due to lower amounts recognized from government
co-funding, primarily due to the end of government funding for our Cray XT5h vector system (formerly
code-named BlackWidow) in the fourth quarter of 2007 and additional development costs associated
with the support of the recently established Intel collaboration, offset in part by delayed
third-party outside services and non-recurring engineering expenses.
For 2008, we anticipate net research and development expenses to increase about 30% from 2007
levels, with increases in gross research and development expenses and decreases in amounts
recognized from government co-funding. This expected increase is
21
driven by the completion of the government funding for the Cray XT5h system, such
that we bear the full cost of further system development, and additional development costs
associated with the support of our collaboration with Intel. We have commenced discussions with
DARPA regarding proposed changes to the DARPA Phase III project, including the incorporation of
Intel technologies into that project. Significant modifications to, or termination of, the DARPA
Phase III contract could have a material adverse impact on our future reported research and
development expense.
Sales and Marketing and General and Administrative Expenses
Our sales and marketing and general and administrative expenses for the three and six months ended
June 30, 2008 and 2007, were (in thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Sales and marketing |
|
$ |
5,848 |
|
|
$ |
5,123 |
|
|
$ |
11,230 |
|
|
$ |
10,391 |
|
Percentage of total revenue |
|
|
13% |
|
|
|
19% |
|
|
|
15% |
|
|
|
14% |
|
General and administrative |
|
$ |
3,465 |
|
|
$ |
3,822 |
|
|
$ |
7,161 |
|
|
$ |
8,102 |
|
Percentage of total revenue |
|
|
7% |
|
|
|
14% |
|
|
|
10% |
|
|
|
11% |
|
Sales and Marketing. Sales and marketing expense for the three and six months ended
June 30, 2008, increased from the same periods in 2007, primarily due to increased headcount,
marketing activities for the second quarter of 2008 and increased sales commissions on higher product
revenue For 2008, we expect sales and marketing expenses will be higher than 2007 levels
primarily due to increased sales commissions on higher anticipated product sales, increased
headcount and higher variable incentive pay amounts.
General and Administrative. General and administrative expenses for the three and six months
ended June 30, 2008, were lower than the same periods in 2007 primarily due to lower outside
services. For 2008, we expect general and administrative expenses to be higher than 2007 expense
levels, principally due to higher expected variable incentive pay amounts.
Other Income (Expense), net
For the three months ended June 30, 2008, we recognized net other income of $540,000 compared
to $76,000 for the same period of 2007. For the six months ended June 30, 2008, we recognized net
other income of $793,000 compared to $471,000 for the same period in 2007. Net other income in
all periods was principally the result of foreign currency transaction gains.
Interest Income (Expense)
Our interest income and interest expense for the three and six months ended June 30, 2008 and
2007 were (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Interest income |
|
$ |
1,031 |
|
|
$ |
1,763 |
|
|
$ |
2,666 |
|
|
$ |
3,598 |
|
Interest expense |
|
|
(777 |
) |
|
|
(797 |
) |
|
|
(1,575 |
) |
|
|
(1,599 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income |
|
$ |
254 |
|
|
$ |
966 |
|
|
$ |
1,091 |
|
|
$ |
1,999 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income decreased during the three and six months ended June 30, 2008 compared to the
same periods in 2007 as a result of lower short-term interest rates and lower average invested cash
balances.
Interest expense for the three months ended June 30, 2008 and 2007 consisted of $600,000 of
interest on our Convertible Notes in each period and non-cash amortization of capitalized issuance
costs of $173,000 and $172,000, respectively. Interest expense for the six months ended June 30,
2008 and 2007 consisted of $1.2 million of interest on our Convertible Notes in each period and
non-cash amortization of capitalized issuance costs of $346,000 and $344,000, respectively.
Taxes
22
We recorded tax expense of $107,000 and $360,000 for the three months ended June 30, 2008 and
2007, respectively. We recorded tax expense of $389,000 and $725,000 for the six months ended June
30, 2008 and 2007, respectively. The tax expense recognized in both 2008 and 2007 is principally
driven by income taxes due in foreign tax jurisdictions.
Liquidity and Capital Resources
Cash and cash equivalents, restricted cash, short-term investments and accounts receivable
totaled $147.2 million at June 30, 2008 compared to $202.8 million at December 31, 2007; cash and
cash equivalents decreased by $30.4 million while short-term investments decreased by $33.7 million
and accounts receivable increased by $8.6 million. At June 30, 2008, we had working capital of
$142.3 million compared to $150.8 million at December 31, 2007.
Net cash used in operating activities for the six months ended June 30, 2008 was $62.9 million
compared to net cash used in operating activities of $17.1 million for the same period in 2007. For
the six months ended June 30, 2008, net cash used in operating activities was principally the
result of our net loss for the period and an increase in inventory and other assets and decreases
in advance research and development payments and deferred revenue, partially offset by an increase
in accounts payable. For the six months ended June 30, 2007, net cash used in operating activities
was principally the result of our net loss for the period, an increase in inventory and decreases
in deferred revenue and advance research and development payments, partially offset by a decrease
in accounts receivable.
Net cash provided by investing activities was $32.0 million for the six months ended June 30,
2008, compared to net cash used in investing activities of $51.5 million for the respective 2007
period. Net cash provided by investing activities for the six months ended June 30, 2008 was due
principally to the sales or maturities of short-term investments partially offset by purchases of
property and equipment. Net cash used by investing activities for the six months ended June 30,
2007 was due principally to the purchase of short-term investments, net of their sales and
maturities, and purchases of property and equipment.
Net cash provided by financing activities reported for the six months ended June 30, 2008, was
$282,000, compared to $1.5 million for the six months ended June 30, 2007. Net cash provided by
financing activities for the six months ended June 30, 2008 resulted primarily from cash received
from the issuance of common stock through our employee stock purchase plan. Net cash provided by
financing activities for the six months ended June 30, 2007 resulted primarily from the exercise of
stock options and the issuance of common stock through our employee stock purchase plan.
Over the next twelve months, our significant cash requirements will relate to operational
expenses, consisting primarily of personnel costs, costs of inventory associated with certain
large-scale product deliveries and spare parts, outside engineering expenses, particularly as we
continue development of our Cray XT4, Cray XT5, Cray XT5h, Cray XMT and successor
systems and internally fund a portion of the expenses on our Cascade project pursuant to the DARPA
Phase III award, interest expense and acquisition of property and equipment. Our remaining 2008
capital budget for property and equipment is approximately $6.8 million. In addition, we lease
certain equipment and facilities used in our operations under operating or capital leases in the
normal course of business. The following table summarizes our contractual obligations through
June 30, 2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amounts Committed by Year |
|
Contractual Obligations |
|
Total |
|
|
2008 |
|
|
2009-2011 |
|
|
2012-2013 |
|
|
Thereafter |
|
Development agreements |
|
$ |
70,607 |
|
|
$ |
25,063 |
|
|
$ |
30,544 |
|
|
$ |
15,000 |
|
|
$ |
|
|
Operating leases |
|
|
5,879 |
|
|
|
1,825 |
|
|
|
2,585 |
|
|
|
536 |
|
|
|
933 |
|
Unrecognized income tax benefits |
|
|
990 |
|
|
|
|
|
|
|
730 |
|
|
|
260 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual cash obligations |
|
$ |
77,476 |
|
|
$ |
26,888 |
|
|
$ |
33,859 |
|
|
$ |
15,796 |
|
|
$ |
933 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We have $80.0 million in aggregate principal amount of outstanding convertible Notes due in 2024. The
Notes bear interest at an annual rate of 3.0%, or $2.4 million per year, and holders of the Notes
may require us to purchase the Notes on December 1, 2009, December 1, 2014 and December 1, 2019 or
upon the occurrence of certain events provided in the indenture governing the Notes. We expect that
we likely will have to purchase all of the Notes in December 2009 and we have begun evaluating our options for repayment. In December 2007, we amended our
line of credit reducing the maximum line of credit to $10.0 million from $25.0 million and
extending the expiration date to June 2009. No amounts were
23
outstanding under this line as of June 30, 2008. As of the same date, we were eligible to use
$4.1 million of this line of credit; the borrowing limitation relates to restrictions from our
outstanding letters of credit.
In our normal course of operations, we have development arrangements under which we engage
outside engineering resources to work on our research and development projects. For the three and
six month periods ended June 30, 2008, we incurred $3.8 million and $7.0 million, respectively, for
such arrangements.
At any particular time, our cash position
is affected by the timing of cash receipts for product sales, maintenance contracts, government co-funding for research and development
activities and our payments for inventory, resulting in significant fluctuations in our cash balance from quarter-to-quarter
and within a quarter. Our principal sources of liquidity are our cash and cash equivalents, short-term investments and cash
from operations. With the acceptances and the anticipated timing of cash receipts for several large systems late in the year,
as well as high levels of inventory purchases in the second half of the year, we anticipate that our cash flow from operations
will be negative for 2008, with a wide range of results possible. Cash resources are expected to be at a low point for
the year at the end of the September quarter due to the working capital cycle associated with the high anticipated level of second
half activity. We will manage our disbursements carefully and may modify our credit facility to permit short-term borrowings, if
necessary, to support the expected high level of business activity during the third quarter. Anticipated cash receipts in the
fourth quarter should exceed expenditures and our cash position should improve significantly, though remaining below the
beginning 2008 level. We expect our cash resources to be adequate for at least the next twelve months.
The adequacy of our cash resources is dependent on the amount and timing of government funding
as well as our ability to sell our products, particularly the Cray XT4, Cray XT5, Cray
XT5h and Cray XMT systems, with adequate margins. Beyond the next twelve months, the
adequacy of our cash resources will largely depend on our success in reestablishing profitable
operations and positive operating cash flows on a sustained basis. See Item 1A. Risk Factors in
Part II below.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to financial market risks, including changes in interest rates and foreign
currency fluctuations.
Interest Rate Risk: We invest our available cash principally in investment-grade debt
instruments of corporate issuers and in debt instruments of the U.S. government and its agencies.
We do not have any derivative instruments in our investment portfolio. We protect and preserve
invested funds by limiting default, market and reinvestment risk. Investments in both fixed-rate
and floating-rate interest earning instruments carry a degree of interest rate risk. Fixed-rate
securities may have their fair market value adversely affected due to a rise in interest rates,
while floating-rate securities may produce less income than expected if interest rates fall. Due in
part to these factors, our future investment income may fall short of expectations due to changes
in interest rates or we may suffer losses in principal if forced to sell securities, which have
declined in market value due to changes in interest rates. The average maturity of our short-term
investments is less than six months. At June 30, 2008, we held a portfolio of highly liquid
investments.
Foreign Currency Risk: We sell our products primarily in North America, Asia and Europe. As a
result, our financial results could be affected by factors such as changes in foreign currency
exchange rates or weak economic conditions in foreign markets. Our products are generally priced in
U.S. dollars, and a strengthening of the dollar could make our products less competitive in foreign
markets. While we commonly sell products with payments in U.S. dollars, our product sales contracts
may call for payment in foreign currencies and to the extent we do so, or engage with our foreign
subsidiaries in transactions deemed to be short-term in nature, we are subject to foreign currency
exchange risks. As of June 30, 2008, we entered into forward exchange contracts that hedge
approximately $37.4 million of anticipated cash receipts on specific foreign currency denominated
sales contracts. These forward contracts hedge the risk of foreign exchange rate changes between
the time that the related contracts were signed and when the cash receipts are expected to be
received. Our foreign maintenance contracts are typically paid in local currencies and provide a
natural hedge against foreign exchange exposure. To the extent that we wish to repatriate any of
these funds to the United States, however, we are subject to foreign exchange risks. As of June 30,
2008, a 10% change in foreign exchange rates could impact our annual earnings and cash flows by
approximately $880,000.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures. Under the supervision and with the
participation of our senior management, including our chief executive officer and chief financial
officer, we conducted an evaluation of the effectiveness of the design and
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operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as of the end of the period covered by this
quarterly report. Based on this evaluation, our chief executive officer and chief financial officer
concluded as of June 30, 2008, that our disclosure controls and procedures were effective such that
the information required to be disclosed in our Securities and Exchange Commission (SEC) reports
(i) is recorded, processed, summarized and reported within the time periods specified in SEC rules
and forms, and (ii) is accumulated and communicated to our management, including our chief
executive officer and chief financial officer, as appropriate to allow timely decisions regarding
required disclosure.
Changes in internal control over financial reporting. There have been no changes in our
internal control over financial reporting that occurred during the quarter ended June 30, 2008 that
have materially affected or are reasonably likely to materially affect our internal control over
financial reporting.
Item 4T. Controls and Procedures
Not applicable.
Part II. OTHER INFORMATION
Item 1A. Risk Factors
The following factors should be considered in evaluating our business, operations, prospects
and common stock as they may affect our future results and financial condition and they may affect
an investment in our securities.
Our operating results may fluctuate significantly and we may not achieve profitability in any
given period. Our operating results are subject to significant fluctuations due to the factors
listed below, which make estimating revenue and operating results for any specific period very
difficult, particularly as the product revenue recognized in any given quarter may depend on a very
limited number of system sales planned for that quarter, the timing of product acceptances by
customers and contractual provisions affecting revenue recognition. For example, we expect a
substantial portion of our potential product revenue in the second half of 2008 to come from a few
major transactions involving our quad-core Cray XT4, Cray XT5 and Cray XT5h systems. Delays in
recognizing revenue from any transaction due to development delays, not receiving needed components
timely or with anticipated performance, not achieving product acceptances, contractual provisions
or for other reasons, could have a material adverse effect on our operating results in any quarter,
and could shift associated revenue, margin and cash receipts into subsequent quarters or calendar
years.
We have experienced net losses in recent periods. For example, in 2005 we had a net loss of
$64.3 million, in 2006 we had a net loss of $12.1 million, in 2007 we had a net loss of $5.7
million, and in the first half of 2008 we had a net loss of $15.7 million.
Whether we will be able to increase our revenue and achieve and sustain profitability on a
quarterly and annual basis depends on a number of factors, including:
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successfully completing development and selling of our Cray XT4, Cray XT5 and Cray XT5h
systems, including upgrades and successor systems; |
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the level of revenue recognized in any given period, which is affected by the very high
average sales prices and limited number of system sales in any quarter, the timing of
product acceptances by customers and contractual provisions affecting the timing and amount
of revenue recognition; |
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our expense levels, including research and development net of government funding, which
are affected by the level and timing of such funding and, in certain circumstances, the
meeting of developmental milestones; |
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maintaining our product development projects on schedule and within budgetary
limitations; |
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the level of product margin contribution in any given period due to product mix,
strategic transactions, product life cycle and component costs; |
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the capacity of our production facility to assemble, test and ship sufficient completed
systems to meet our revenue forecast; |
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the level and timing of maintenance contract renewals with existing customers; |
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revenue delays or losses due to customers postponing purchases to wait for future
upgraded or new systems, delays in delivery of upgraded or new systems and longer than
expected customer acceptance cycles; |
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the terms and conditions of sale or lease for our products; and |
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the impact of expensing our share-based compensation under Statement of Financial
Accounting Standards No. 123(R), Share-Based Payment. |
The timing of orders and shipments impacts our quarterly and annual results and is affected by
events outside our control, such as:
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the timely availability of acceptable components in sufficient quantities to meet
customer delivery schedules; |
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the timing and level of government funding for product acquisitions and research and
development contracts; |
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price fluctuations in the commodity electronics and memory markets; |
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the availability of adequate customer facilities to install and operate new Cray systems; |
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general economic trends, including changes in levels of customer capital spending; |
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the introduction or announcement of competitive products; |
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currency fluctuations, international conflicts or economic crises; and |
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the receipt and timing of necessary export licenses. |
Because of the numerous factors affecting our revenue and results of operations, we cannot
assure our investors that we will have net income on a quarterly or annual basis in the future. We
anticipate that our quarterly results will fluctuate significantly, and include losses. Delays in
component availability, product development, receipt of orders and product acceptances had a
substantial adverse effect on our results for the first half of 2008 and quarterly and full year
results for 2007 and prior years, and could continue to have such an effect on our remaining
quarterly and annual results in 2008 and future years.
Our reliance on third-party suppliers poses significant risks to our operating results,
business and prospects. We subcontract the manufacture of a majority of the hardware components for
all of our products, including integrated circuits, printed circuit boards, connectors, cables,
power supplies and memory parts, on a sole or limited source basis to third-party suppliers. We use
contract manufacturers to assemble our components for all of our systems. We also rely on third
parties to supply key capabilities, such as file systems and storage subsystems. We use key service
providers to co-develop key technologies, including integrated circuit design and verification. We
are subject to substantial risks because of our reliance on limited or sole source suppliers. For
example:
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if a supplier does not provide components that meet our specifications in sufficient
quantities on time, then production and sales of our systems would be delayed or result in
decreased gross margin, adversely affecting revenue and cash flow these risks are
accentuated during steep production ramp periods as we introduce new
or successor products, such as our current production ramp for our
Cray XT5 system; |
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if an interruption of supply of our components occurs because of a significant problem
with a supplier providing parts that later prove to be defective or because a single-source
supplier imposes allocations on its customers, decides to no longer provide those components
to us or increases the price of those parts significantly, it could take us a considerable
period of time to identify and qualify alternative suppliers, to redesign our products as
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redesigned components. In some cases, we may not be able to redesign such components.
Defective components may need to be replaced, which may result in increased costs and
obsolete inventory; |
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if a supplier provides us with hardware, software or other intellectual property that
contains bugs or other errors or is different from what we expected, our development
projects may be adversely affected through additional design testing and verification
efforts and respins of integrated circuits; |
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if a supplier providing us with key research and development services with respect to
integrated circuit design, network communication capabilities or internal software is late,
fails to provide us with effective designs or products or loses key internal talent, our
development programs may be delayed or prove to be not possible to complete; |
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if a supplier cannot provide a competitive key component, our
systems may be less
competitive than systems using components with greater capability; |
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some of our key component and service suppliers are small companies with limited
financial and other resources, and consequently may be more likely to experience financial
and operational difficulties than larger, well-established companies; and |
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if a key supplier is acquired or has a significant business change, production and sales
of our systems may be delayed or our development programs may be delayed or may not be
possible to complete. |
We have stated that achievement of our plan to be profitable in 2008 depends heavily on the
acceptance of the Oak Ridge National Laboratory Cray XT5 petaflops supercomputer system late in the year.
We recently have received unqualified components for the Cray XT5
system, and to the extent that we have any additional delays in receiving or other issues with acceptable components from
third parties, the manufacture, delivery and acceptance of that
system in 2008 would be at significant
risk.
To the extent that Intel, IBM or other processor suppliers develop processors with greater
capabilities, even for a short time, our systems, including upgrades and successor products, may be
at a competitive disadvantage to systems utilizing such other processors. Our Cray XT4 and Cray XT5
systems are based on certain Opteron processors from AMD, while our
Cray XT5h system is based on
custom integrated circuits manufactured for us by Texas Instruments, Inc. Delays in the
availability of AMD Opteron processors have adversely affected our revenue and operating
results in the fourth quarter of 2007 and first half of 2008 and could continue to adversely affect
results for the remainder of 2008. If any of our integrated circuit suppliers suffers delays or
cancels the development of enhancements to its processors, our product revenue, margins and
operating results would be adversely affected. Our collaboration with Intel announced in April 2008
will not mitigate this risk for several years.
The achievement of our business plan in 2008 and future periods is highly dependent on
increased product revenue and margins from our Cray XT4, Cray XT5 and
Cray XT5h and successor
systems. Product revenue and operating results in recent periods, including 2007 and the first half
of 2008, were adversely affected by the unavailability of key components from third-party vendors
and by development delays, including system software development for large systems. We expect that
a substantial majority of our product revenue in the second half of 2008 will come from a limited
number of sales of quad-core Cray XT4, Cray XT5 and Cray
XT5h systems in the United States and
overseas. We began delivering quad-core Cray XT4 processors for field upgrades late in the fourth
quarter of 2007, and we recognized initial revenue from our quad-core Cray XT4 system in the second
quarter of 2008; we expect initial deliveries of quad-core Cray XT5 systems to occur in the third
quarter with initial acceptances of those systems in the fourth
quarter of 2008. With procurements for
large systems that require that we link together multiple cabinets containing powerful processors
and other components into an integrated system, our Cray XT4, Cray
XT5 and Cray XT5h systems must
scale to unprecedented levels of performance. During our internal testing and the customer
acceptance processes, we may discover that we cannot achieve acceptable system stability across
these large systems without incurring significant additional delays and expense. Any additional
delays in receiving acceptable components or in product development, assembly, final testing and
obtaining large system stability would delay delivery, installation and acceptance of Cray XT4 and
Cray XT5 systems, including the Oak Ridge National Laboratory petaflops systems, and would impact
2008 and future operating results adversely.
Several factors affect our ability to obtain higher margins for our products, such as:
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the level of product differentiation in our Cray XT4, Cray XT5 and successor systems. The
market for such products is large but is replete with low bandwidth cluster systems. Our
long-term success may be adversely affected if we are not successful in demonstrating the
value of our balanced high bandwidth systems with the capability of solving challenging
problems quickly to a market beyond our current core of customers, largely certain agencies
of the U.S. and other governments, that require systems with the performance and features we
offer; |
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in the past, product margins have been adversely impacted by lower volumes than planned
and higher than anticipated manufacturing variances, including scrap, rework and excess and
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in March 2008, we placed a last-time buy for a key component for our Cray XT4, Cray XT5
and Cray XMT systems, which had to be placed before we could know all the possible sales
prospects for these products. If we estimated our needs too low, we could limit the number
of possible sales of these products and reduce potential revenue, or if we estimated too
high, we could incur inventory obsolescence charges and reduce our margins. Either way, our
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we sometimes do not meet all of the contract requirements for
customer acceptance and ongoing reliability of our
systems, which has resulted in contract penalties. Most often these penalties adversely
affect the gross margin through the provision of additional equipment
and services and/or service credits
to satisfy delivery delays and performance shortfalls, although there is the risk of
contract defaults and product return. Such penalties adversely impacted gross margins in
2007 and the first half of 2008, and we expect additional penalties in the second half of
2008. The risk of contract penalties is increased when we bid for new business prior to
completing development of new products when we must estimate future system performance. |
To improve our financial performance, we need greater product differentiation and to limit
negative manufacturing variances, contract penalties and other charges that adversely affect
product margin, and failure to do so will adversely affect our operating results.
Failure to obtain the consent of DARPA to the incorporation of Intel technologies into our
Cascade project and other proposed changes could lead to a termination of our DARPA HPCS program,
which would impact our desired strategy and result in a significant increase in our research and
development expenditures and reduced operating results. The DARPA High Productivity Computing
Systems (HPCS) program calls for the delivery of prototype systems and provides for
a contribution by DARPA to us of up to $250 million payable over approximately four years, assuming
we meet ten milestones. We have met three of these milestones through June 30, 2008. We are
negotiating with DARPA changes to the scope and schedule of this program, including changes to
incorporate Intel technologies and later delivery dates, new milestones and new payment dates and
amounts. If we are unable to renegotiate the terms of the
program, or, even if we succeed in our
negotiations but are unable to meet the remaining milestones, either of which may lead to a
termination of the program, our cash flows and expenses would be adversely impacted and our product
development programs would be at risk. DARPAs future financial commitments are subject to
subsequent Congressional and federal inter-agency action, and our Cascade development efforts and
the level of reported research and development expenses would be adversely impacted if DARPA did
not receive expected funding, delayed payment for completed milestones, delayed the timing of
milestones or decided to terminate the program before completion. We incurred some delays in
payments and program milestones by DARPA in 2007 and 2008, with additional delays possible. The amount of
DARPA funds we can recognize as an offset to our periodic research and development expenses depends
on our estimates of the total costs and the time to complete the program; changes in our estimates
may decrease the amount of funding recognized in any period, which may increase the amount of net
research and development expense recognized in that quarter. By the projects completion, we must
have contributed at least $125 million towards the projects total development cost; failure to do
so would result in a lower level of DARPA contribution and could result in a termination of the
contract. The DARPA program will result in increased net research and development expenditures by
us for the cost-sharing portion of the program and will adversely affect our cash flow,
particularly in the later years of the program.
Failure to overcome the technical challenges of completing the development of our
supercomputer systems on our product roadmap would adversely affect our revenue and operating
results in subsequent years. In addition to developing the scalable system software and hardware
for quad-core Cray XT4, Cray XT5 and Cray XT5h systems for revenue generation in 2008, we continue
to work on our product roadmap, including the Cray XMT system and successor systems to the Cray XT5
system, and our incorporating Intel technologies into and completing our Cascade program under the
DARPA HPCS Phase III program, assuming DARPA so consents. These development efforts are lengthy and
technically challenging processes, and require a significant
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investment of capital, engineering and other resources. Unanticipated performance and/or
development issues may require more engineers, time or testing resources than are currently
available. Directing engineering resources to solving current issues has adversely affected the
timely development of successor or future products. Given the breadth of our engineering challenges
and our limited engineering and technical personnel resources, we periodically review the
anticipated contributions and expense of our product programs to determine their long-term
viability. We may not be successful in meeting our development schedules for technical reasons
and/or because of insufficient engineering resources, which could cause a lack of confidence in our
capabilities among our key customers. To the extent we incur delays in completing the design,
development and production of hardware components, delays in development of requisite system
software, cancellation of programs due to technical infeasibility or uncover stability issues, our
revenue, results of operations and cash flows, and the reputation of such systems in the market,
could be adversely affected. Future sales of our products may be adversely affected by any of these
factors.
If the U.S. government purchases fewer supercomputers, our revenue would be reduced and our
operating results would be adversely affected. Historically, sales to the U.S. government and
customers primarily serving the U.S. government have represented a significant market for
supercomputers, including our products. In 2005, 2006, 2007 and the first half of 2008,
approximately 55%, 45%, 64% and 72%, respectively, of our product revenue was derived from such
sales. Our 2008 and future plans contemplate significant sales to U.S. government agencies. Sales
to government agencies, including cancellations of existing contracts, may be affected by factors
outside our control, such as changes in procurement policies, budgetary considerations including
Congressional delays in completing appropriation bills, domestic crises, and international
political developments. If agencies and departments of the United States or other governments were
to stop, reduce or delay their use and purchases of supercomputers, our revenue and operating
results would be adversely affected.
We will require a significant amount of cash to purchase the Notes and to fund planned capital
expenditures, research and development efforts and other corporate expenses and may have to seek
additional financing. On December 1, 2009, December 1, 2014 or December 1, 2019, holders of our
$80.0 million principal amount of 3.0% Convertible Senior Subordinated Notes due 2024 (the Notes)
may require us to purchase their Notes for cash, and we currently expect that we likely will be
required to purchase all the Notes on December 1, 2009. In addition, holders may also require us to
purchase their Notes upon a fundamental change, as defined in the indenture governing the Notes,
which includes among other matters, a change of control. Our ability to repurchase the Notes in
such events may be limited by law and by the terms of other indebtedness, we may have outstanding
at the time of such events. If we do not have sufficient funds, we will not be able to repurchase
the Notes tendered to us for purchase. Our ability to make payments on our indebtedness, including
the potential repurchase of the Notes in December 2009, and to fund planned capital expenditures,
research and development efforts and other corporate expenses will depend on our future operating
performance and on economic, financial, competitive, legislative, regulatory and other factors.
Many of these factors are beyond our control. Our business may not generate sufficient cash from
operations, and we expect to have a net use of cash in 2008 as a whole, and future borrowings may
not be available to us in an amount sufficient to enable us to pay our indebtedness, including the
Notes, or to fund our other needs. If we are unable to generate sufficient cash to enable us to pay
our indebtedness, we may need to pursue one or more alternatives, such as reducing our operating
expenses, reducing or delaying capital expenditures or research and development, selling assets,
raising additional equity capital and/or debt, and seeking legal protection from our creditors.
There can be no assurance that we will be successful in our efforts to achieve future profitable
operations or generate sufficient cash from operations, or that we would obtain additional funding
through a financing in the event our financial resources became insufficient. A financing, even if
available, may not be available on satisfactory terms, may contain restrictions on our operations,
and if involving equity or debt securities could reduce the percentage ownership of our
shareholders, may cause additional dilution to our shareholders and the securities may have rights,
preferences and privileges senior to our common stock.
If we are unable to compete successfully in the HPC market, our revenue will decline. The
performance of our products may not be competitive with the computer systems offered by our
competitors. Many of our competitors are established companies well known in the HPC market,
including IBM, NEC, Hewlett-Packard, Fujitsu, Hitachi, SGI, Dell, Bull S.A. and Sun Microsystems.
Most of these competitors have substantially greater research, engineering, manufacturing,
marketing and financial resources than we do. We also compete with systems builders and resellers
of systems that are constructed from commodity components using processors manufactured by Intel,
AMD, IBM and others. These competitors include the previously named companies as well as smaller
firms that benefit from the low research and development costs needed to assemble systems from
commercially available commodity products. Such companies, because they can offer high peak
performance per dollar, can put pricing pressure on us in certain competitive procurements. In
addition, to the extent that Intel, IBM and other processor suppliers develop processors with
greater capabilities than the processors we use from AMD, our Cray XT4, Cray XT5 and successor
systems may be at a competitive
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disadvantage to systems utilizing such other processors. Our April 2008 collaboration with
Intel will not mitigate this risk for several years.
Periodic announcements by our competitors of new HPC systems or plans for future systems and
price adjustments may reduce customer demand for our products. Many of our potential customers
already own or lease very high performance computer systems. Some of our competitors may offer
trade-in allowances or substantial discounts to potential customers, and engage in other aggressive
pricing tactics, and we have not always been able to match these sales incentives. We have in the
past and may again be required to provide substantial discounts to make strategic sales, which may
reduce or eliminate any positive margin on such transactions, or to provide lease financing for our
products, which could result in a deferral of our receipt of cash and revenue for these systems.
These developments limit our revenue and resources and reduce our ability to be profitable.
Our market is characterized by rapidly changing technology, accelerated product obsolescence
and continuously evolving industry standards. Our success depends upon our ability to sell our
current products, and to develop successor systems and enhancements in a timely manner to meet
evolving customer requirements, which may be influenced by competitive offerings. We may not
succeed in these efforts. Even if we succeed, products or technologies developed by others may
render our products or technologies noncompetitive or obsolete. A breakthrough in technology could
make low bandwidth cluster systems even more attractive to our existing and potential customers.
Such a breakthrough would impair our ability to sell our products and would reduce our revenue and
operating results.
Expansion of new Cray Technical Services could reduce our overall service margins. We plan to
continue to expand our capabilities to deliver Cray Technical Services through the addition
of experienced managers and new personnel, marketing of these services and commencing new projects,
including undertaking potentially significant custom engineering projects. To the extent that we
incur additional expenses in this effort prior to receiving additional revenue, our overall service
margins will be adversely affected, as were our second quarter 2008 service margins. At least
initially most of these new projects will be for the U.S. government and likely require us to enter
agreements subject to, from our perspective, new or additional Federal Acquisition Regulations,
including costing and pricing requirements. These regulations are complex and subject to audit to
insure compliance. We may need to enhance existing financial and costing systems to accommodate
these new requirements. Errors made in interpreting and complying with these regulations could
result in significant penalties.
Our indebtedness may adversely affect our financial strength. In December 2004 we sold $80.0
million in aggregate principal amount of the Notes. Holders may require us to purchase all or a
part of their Notes for cash at a purchase price of 100% of the principal amount of the Notes plus
accrued and unpaid interest on December 1, 2009, December 1, 2014 or December 1, 2019, or upon the
occurrence of certain events provided in the indenture governing the Notes. As of June 30, 2008, we
had no other outstanding indebtedness for money borrowed and no material equipment lease
obligations. We have a $10.0 million cash secured credit facility which supports the issuance of
letters of credit. As of June 30, 2008, we had approximately $4.1 million available to use under
this credit facility. Our current credit facility constitutes senior debt with respect to the
Notes. We may incur additional indebtedness for money borrowed, which may include borrowing under
new credit facilities or the issuance of new debt securities, including a potential refinancing of
the Notes. Over time, the level of our indebtedness could, among other things:
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increase our vulnerability to general economic and industry conditions, including
recessions; |
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require us to use cash from operations to service our indebtedness, thereby reducing our
ability to fund working capital, capital expenditures, research and development efforts and
other expenses; |
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limit our flexibility investing in significant research and development projects with
long paybacks, as well as our flexibility in planning for, or reacting to, changes in our
business, including merger and acquisition opportunities; |
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place us at a competitive disadvantage compared to competitors that have less
indebtedness; and |
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limit our ability to borrow additional funds that may be needed to operate and expand our
business. |
If we cannot retain, attract and motivate key personnel, we may be unable to effectively
implement our business plan. Our success depends in large part upon our ability to retain, attract
and motivate highly skilled management, technical, marketing, sales and service personnel. The loss
of and failure to replace key engineering management and personnel could adversely affect multiple
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development efforts. Recruitment and retention of senior management and skilled technical,
sales and other personnel is very competitive, and we may not be successful in either attracting or
retaining such personnel. From time to time, we have lost key personnel to other high technology companies. As part of our strategy to attract and retain key personnel, we
may offer equity compensation through stock options and restricted stock grants. Potential
employees, however, may not perceive our equity incentives as attractive, and current employees who
have significant options with exercise prices significantly above current market values for our
common stock may seek other employment. In addition, due to the intense competition for qualified
employees, we may be required to increase the level of compensation paid to existing and new
employees, which could materially increase our operating expenses.
Our stock price is volatile. The trading price of our common stock is subject to significant
fluctuations in response to many factors, including our quarterly operating results (particularly
if they are less than our or analysts previous estimates), changes in analysts estimates, our
capital raising activities, announcements of technological innovations by us or our competitors and
general conditions in our industry.
Lower than anticipated sales of new supercomputers and the termination of maintenance
contracts on older and/or decommissioned systems may reduce our service revenue and margins from
maintenance service contracts. Our HPC systems are typically sold with maintenance service
contracts. These contracts generally are for annual periods, although some are for multi-year
periods, and provide a predictable revenue base. Our revenue from maintenance service contracts
declined from approximately $95 million in 2000 to approximately $42 million in 2005 while
increasing to approximately $50 million in 2006 and since then has stabilized at about this level.
We may have periodic revenue and margin declines as our older, higher margin service contracts are
ended and newer, lower margin contracts are established, based on the timing of system withdrawals
from service. Adding service personnel to new locations when we win contracts where we have
previously had no presence and servicing installed products to replace defective components in the
field create additional pressure on service margins.
We may infringe or be subject to claims that we infringe the intellectual property rights of
others. Third parties in the past have asserted, and may in the future assert intellectual property
infringement claims against us, and such future claims, if proved, could require us to pay
substantial damages or to redesign our existing products or pay fees to obtain cross-license
agreements. Regardless of the merits, any claim of infringement would require management attention
and could be expensive to defend.
We incorporate software licensed from third parties into the operating systems for our
products and any significant interruption in the availability of these third-party software
products or defects in these products could reduce the demand for our products. The operating
system software we develop for our HPC systems contains components that are licensed to us under
open source software licenses. Our business could be disrupted if this software, or functional
equivalents of this software, were either no longer available to us or no longer offered to us on
commercially reasonable terms. In either case we would be required to redesign our operating system
software to function with alternative third-party software, or develop these components ourselves,
which would result in increased costs and could result in delays in product shipments. Our Cray
XT4, Cray XT5 and successor systems utilize software system variants that incorporate Linux
technology. The open source licenses under which we have obtained certain components of our
operating system software may not be enforceable. Any ruling by a court that these licenses are not
enforceable, or that Linux-based operating systems, or significant portions of them, may not be
copied, modified or distributed as provided in those licenses, would adversely affect our ability
to sell our systems. In addition, as a result of concerns about the risks of litigation and open
source software generally, we may be forced to protect our customers from potential claims of
infringement. In any such event, our financial condition and results of operations may be adversely
affected.
We also incorporate proprietary incidental software from third parties, such as for file
systems, job scheduling and storage subsystems. We have experienced some functional issues in the
past with implementing such software with our supercomputer systems. These issues, if repeated, may
result in additional expense by us and/or loss of customer confidence.
We are required to evaluate our internal control over financial reporting under Section 404 of
the Sarbanes-Oxley Act of 2002 at the end of each fiscal year, and any adverse results from such
future evaluations could result in a loss of investor confidence in our financial reports and have
an adverse effect on our stock price. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we
are required to furnish a report by our management and our independent registered public accounting
firm on our internal control over financial reporting in our Annual Reports on Form 10-K. We
received favorable opinions from our independent registered public accounting firm and we reported
no material weaknesses for 2005, 2006 and 2007. Each year, we must continue to monitor and assess
our internal control over financial reporting and determine whether we have any material
weaknesses. Depending
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on their nature and severity, any future material weaknesses could result in our having to
restate financial statements, could make it difficult or impossible for us to obtain an audit of
our annual financial statements or could result in a qualification of any such audit. In such
events, we could experience a number of adverse consequences, including our inability to comply
with applicable reporting and listing requirements, a loss of market confidence in our publicly
available information, delisting from the Nasdaq Global Market, an inability to complete a
financing, loss of other financing sources such as our line of credit, and litigation based on the
events themselves or their consequences.
U.S. export controls could hinder our ability to make sales to foreign customers and our
future prospects. The U.S. government regulates the export of HPC systems such as our products.
Occasionally we have experienced delays for up to several months in receiving appropriate approvals
necessary for certain sales, which have delayed the shipment of our products. Delay or denial in
the granting of any required licenses could make it more difficult to make sales to foreign
customers, eliminating an important source of potential revenue.
New environmental rules in Europe and other jurisdictions may adversely affect our operations.
In 2006 members of the European Union (EU) and certain other European countries began
implementing the Restrictions on Hazardous Substances (RoHS) Directive, which prohibits or limits
the use in electrical and electronic equipment of the following substances: lead, mercury, cadmium,
hexavalent chromium, polybrominated biphenyls, and polybrominated diphenyl ethers. After July 1,
2006, a company shipping products that do not comply with RoHS to the EU or such other European
countries could have its products detained and could be subject to penalties. We believe we are or
will be RoHS-compliant with our Cray XT4, Cray XT5 and Cray
XT5h systems. If a regulatory
authority determines that any of our products is not RoHS-compliant, we will have to redesign and
requalify certain components to meet RoHS requirements, which could result in increased engineering
expenses, shipment delays, penalties and possible product detentions or seizures.
A separate EU Directive on Waste Electrical and Electronic Equipment (WEEE) was scheduled to
become effective in August 2005. Under the WEEE Directive, companies that put electrical and
electronic equipment on the EU market must register with individual member states, mark their
products, submit annual reports, provide recyclers with information about product recycling, and
either recycle their products or participate in or fund mandatory recycling schemes. In addition,
some EU member states require recycling fees to be paid in advance to ensure funds are available
for product recycling at the end of the products useful life. We mark our products as required by
the WEEE Directive and are registered with those EU member states where our products have been
shipped since August 2005. Each EU member state is responsible for implementing the WEEE Directive
and some member states have not yet established WEEE registrars or established or endorsed the
recycling schemes required by the WEEE Directive. We are monitoring implementation of the WEEE
Directive by the member states. Compliance with the WEEE Directive could increase our costs and any
failure to comply with the WEEE Directive could lead to monetary penalties.
Other jurisdictions are considering adoption of rules similar to the RoHS and WEEE
regulations. To the extent that any such rules differ from the RoHS and WEEE regulations, they may
result in additional expense for us to redesign and requalify our products, and may delay us from
shipping products into such jurisdictions.
We may not be able to protect our proprietary information and rights adequately. We rely on a
combination of patent, copyright and trade secret protection, nondisclosure agreements and
licensing arrangements to establish, protect and enforce our proprietary information and rights. We
have a number of patents and have additional applications pending. There can be no assurance,
however, that patents will be issued from the pending applications or that any issued patents will
protect adequately those aspects of our technology to which such patents will relate. Despite our
efforts to safeguard and maintain our proprietary rights, we cannot be certain that we will succeed
in doing so or that our competitors will not independently develop or patent technologies that are
substantially equivalent or superior to our technologies. The laws of some countries do not protect
intellectual property rights to the same extent or in the same manner as do the laws of the United
States. Additionally, under certain conditions, the U.S. government might obtain non-exclusive
rights to certain of our intellectual property. Although we continue to implement protective
measures and intend to defend our proprietary rights vigorously, these efforts may not be
successful.
A substantial number of our shares are eligible for future sale and may depress the market
price of our common stock and may hinder our ability to obtain additional financing. As of June 30,
2008, we had outstanding:
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33,364,934 shares of common stock; |
32
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1,284,852 shares of common stock issuable upon exercise of warrants; |
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4,021,382 shares of common stock issuable upon exercise of options, of which options to
purchase 2,680,572 shares of common stock were then exercisable; and |
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Notes convertible into an aggregate of 4,144,008 shares of common stock at a current
conversion price of approximately $19.31 per share, subject to adjustment, or, under certain
circumstances specified in the indenture governing the Notes, a maximum of 5,698,006 shares
of common stock. |
Almost all of our outstanding shares of common stock may be sold without substantial
restrictions, with certain exceptions including, as of June 30, 2008, an aggregate of 771,735
shares held by Board members, executive officers and key managers that may be forfeited and are
restricted against transfer until vested.
Almost all of the shares of common stock that may be issued on exercise of the warrants and
options will be available for sale in the public market when issued, subject in some cases to
volume and other limitations. The warrants outstanding at June 30, 2008, consisted of warrants to
purchase 1,284,852 shares of common stock, with an exercise price of $10.12 per share, expiring on
June 21, 2009. The Notes are not now convertible, and only become convertible upon the occurrence
of certain events specified in the indenture governing the Notes. Sales in the public market of
substantial amounts of our common stock, including sales of common stock issuable upon the exercise
or conversion of warrants, options and Notes, may depress prevailing market prices for the common
stock. Even the perception that sales could occur may impact market prices adversely. The existence
of outstanding warrants, options and Notes may prove to be a hindrance to our future financings.
Further, the holders of warrants, options and Notes may exercise or convert them for shares of
common stock at a time when we would otherwise be able to obtain additional equity capital on terms
more favorable to us. Such factors could impair our ability to meet our capital needs. We also have
authorized 5,000,000 shares of undesignated preferred stock, although no shares of preferred stock
currently are outstanding.
Provisions of our Restated Articles of Incorporation and Bylaws could make a proposed
acquisition that is not approved by our Board of Directors more difficult. Provisions of our
Restated Articles of Incorporation and Bylaws could make it more difficult for a third party to
acquire us. These provisions could limit the price that investors might be willing to pay in the
future for our common stock. For example, our Restated Articles of Incorporation and Bylaws provide
for:
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removal of a director only in limited circumstances and only upon the affirmative vote of
not less than two-thirds of the shares entitled to vote to elect directors; |
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the ability of our board of directors to issue up to 5,000,000 shares of preferred stock,
without shareholder approval, with rights senior to those of the common stock; |
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no cumulative voting of shares; |
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the right of shareholders to call a special meeting of the shareholders only upon demand
by the holders of not less than 30% of the shares entitled to vote at such a meeting; |
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the affirmative vote of not less than two-thirds of the outstanding shares entitled to
vote on an amendment, unless the amendment was approved by a majority of our continuing
directors, who are defined as directors who have either served as a director since August
31, 1995, or were nominated to be a director by the continuing directors; |
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special voting requirements for mergers and other business combinations, unless the
proposed transaction was approved by a majority of continuing directors; |
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special procedures to bring matters before our shareholders at our annual shareholders
meeting; and |
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special procedures to nominate members for election to our board of directors. |
These provisions could delay, defer or prevent a merger, consolidation, takeover or other
business transaction between us and a third party that is not approved by our Board of Directors.
33
Item 4. Submission of Matters to a Vote of Security Holders
Our annual meeting of shareholders was held on May 14, 2008. At the annual meeting, the
following actions occurred:
1. The following individuals were re-elected as directors for terms expiring in 2009:
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Name |
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Votes For |
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% For |
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Withheld |
|
% Withheld |
William C. Blake |
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27,299,009 |
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97.0 |
% |
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845,421 |
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3.0 |
% |
John B. Jones, Jr. |
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27,470,814 |
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97.6 |
% |
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673,616 |
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2.4 |
% |
Stephen C. Kiely |
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27,451,887 |
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97.5 |
% |
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692,543 |
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2.5 |
% |
Frank L. Lederman |
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27,469,936 |
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97.6 |
% |
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674,494 |
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2.4 |
% |
Sally G. Narodick |
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27,454,479 |
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97.5 |
% |
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689,951 |
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2.5 |
% |
Daniel C. Regis |
|
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27,456,727 |
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97.6 |
% |
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687,703 |
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2.4 |
% |
Stephen C. Richards |
|
|
27,473,649 |
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97.6 |
% |
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670,781 |
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2.4 |
% |
Peter J. Ungaro |
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27,468,252 |
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97.6 |
% |
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676,178 |
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2.4 |
% |
2. A proposal to ratify the appointment of Peterson Sullivan PLLC as the Companys
independent auditors for 2008 was approved by the shareholders, with 27,889,193 shares voting in
favor (99.1 %), 216,545 shares voting against (0.8%) and 38,692 shares abstaining (0.1%).
Item 6. Exhibits
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10.1
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Cray Cash Incentive Plan, as applicable to senior officers (1) |
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31.1
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Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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31.2
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Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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32.1
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Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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(1) |
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Incorporated by reference to the Companys Current Report on Form 8-K, as filed with the SEC
on May 14, 2008 |
Items 1, 2, 3 and 5 of Part II are not applicable and have been omitted.
34
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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CRAY INC.
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Date: August 4, 2008 |
/s/ PETER J. UNGARO
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Peter J. Ungaro |
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Chief Executive Officer and President |
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/s/ BRIAN C. HENRY
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Brian C. Henry |
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Chief Financial Officer |
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/s/ KENNETH D. ROSELLI
|
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Kenneth D. Roselli |
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Chief Accounting Officer |
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35